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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


Form 10-K

     
(Mark One)
   
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the fiscal year ended December 31, 2003
 
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the transition period from           to

Commission File Number: 0-17995


Zix Corporation

(Exact Name of Registrant as Specified in its Charter)
     
Texas   75-2216818
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer Identification Number)

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

(Address of Principal Executive Offices)

(214) 370-2000

(Registrant’s Telephone Number, Including Area Code)

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

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

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

Common Stock

$0.01 Par Value
(Title of Class)

     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.




TABLE OF CONTENTS

PART I
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to Vote of Security Holders
PART II
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
NOTE ON FORWARD-LOOKING STATEMENTS AND RISK FACTORS
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
Item 9A. Controls and Procedures
PART III
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions
Item 14. Principal Accountant Fees and Services
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
SIGNATURES
1992 Stock Option Plan (as amended and restated)
2001 Stock Option Plan (as amended and restated)
2003 New Employee Stock Option Plan
401(k) Retirement Plan
Adoption Agreement re: 401(k) Retirement Plan
Employment Agreement - Richard Spurr
Stock Option Agreement - Richard Spurr
Employment Agreement - Daniel S. Nutkis
Stock Option Agreement - Daniel S. Nutkis
Stock Option Agreement - Brad Almond
Lease Agreement - 7-Eleven, Inc.
Sublease
Hawkston Hall Office Centre Lease Agreement
Lease Agreement
Sublease Agreement
Third Sublease Amendment
Facilities Service Agreement
Lease
Subsidiaries
Consent of Independent Auditors
Certification of CEO Pursuant to Section 302
Certification of CFO Pursuant to Section 302
Certification of CEO Pursuant to Section 906
Certification of CFO Pursuant to Section 906


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PART I

 
Item 1. Business

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 CenterTM, 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 DeliveryTM 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

 
Communications Protection Solutions
 
General Description of our Encryption and Delivery Technology for Secure Messaging

      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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ZixCorp’s unique Best Method of Delivery and service capabilities, it provides several added levels of security while assuming the burden of managing users’ public keys. These additional security components are:

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

      ZixCorp’s core technology and Best Method of Delivery 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

      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

      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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email traffic, to protect from risks, and to enforce corporate policies. ZixAuditor also provides a means to monitor ongoing effectiveness and to refine policies. Organizations may purchase pre- or post-installation audits or a regular program of ongoing audits for monitoring purposes. We believe this service to be unique in the industry and a factor contributing to ZixCorp’s expertise in the application of secure email solutions.

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

 
ZixMail

      ZixMail is a secure 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

      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

      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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configured to automatically accept email from all recipients of outgoing messages sent by the user; and dual virus-scanning platforms that offer users the choice of utilizing either or both leading anti-virus programs.
 
Web Inspector

      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.

 
Care Delivery Solutions
 
PocketScript

      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

      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.

 
MyDocOnline Dr. Chart

      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.

 
Communications Protection Solutions Competition

      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.

 
Care Delivery Solutions Competition

      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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the healthcare market. As part of these efforts, we have used targeted direct mail, print, on-line, and email initiatives.

      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 CenterTM. 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.

 
Item 2. Properties

      ZixCorp leases approximately 38,400 square feet of space for our corporate offices and ZixSecure Center operations in Dallas, Texas under two subleases that expire in September 2004. 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.
 
Item 3. Legal Proceedings

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

 
Item 4. Submission of Matters to Vote of Security Holders

      None.

PART II

 
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

      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.

                                 
2003 2002


Quarter Ended High Low High Low





March 31
  $ 5.13     $ 3.90     $ 6.58     $ 3.56  
June 30
  $ 5.43     $ 3.72     $ 6.38     $ 4.05  
September 30
  $ 10.00     $ 3.09     $ 6.10     $ 2.15  
December 31
  $ 10.10     $ 6.36     $ 5.80     $ 3.54  

      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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Act of 1933, as amended (the “Act”) as a private placement effected in reliance on the exemption from registration afforded by Rule 505 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.

      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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Item 6. Selected Financial Data

      The following table sets forth selected financial data regarding the Company’s results of operations and financial position for, and as of the end of, each of the years in the five-year period ended December 31, 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.

                                           
Year Ended December 31,

2003 2002 2001 2000 1999





(In thousands, except per share data)
Statement of Operations Data(1):
                                       
Revenues
  $ 5,840     $ 1,672     $ 317     $ 394     $ 99  
Cost of revenues(2)
    (8,211 )     (8,999 )     (14,996 )     (10,821 )     (4,289 )
Research and development expenses(2)
    (5,896 )     (6,180 )     (9,019 )     (8,661 )     (23,548 )
Selling, general and administrative expenses(2)
    (19,907 )     (19,335 )     (29,892 )     (32,162 )     (12,407 )
Investment and other income
    138       319       2,187       3,130       3,533  
Interest expense(3)
    (13 )     (2,141 )                  
Realized and unrealized gains (losses) on investments(4)
    530       96       (5,391 )     (1,202 )      
     
     
     
     
     
 
Loss from continuing operations before income taxes
    (27,519 )     (34,568 )     (56,794 )     (49,322 )     (36,612 )
Income taxes
    (148 )     269                   807  
     
     
     
     
     
 
Loss from continuing operations
    (27,667 )     (34,299 )     (56,794 )     (49,322 )     (35,805 )
Discontinued operations(1)
    89       862       48       441       1,453  
     
     
     
     
     
 
Net loss
  $ (27,578 )   $ (33,437 )   $ (56,746 )   $ (48,881 )   $ (34,352 )
     
     
     
     
     
 
Basic and diluted earnings (loss) per common share(5)
                                       
 
Continuing operations
  $ (1.23 )   $ (2.07 )   $ (3.32 )   $ (3.03 )   $ (2.35 )
 
Discontinued operations
          0.05             0.03       0.10  
     
     
     
     
     
 
 
Net loss
  $ (1.23 )   $ (2.02 )   $ (3.32 )   $ (3.00 )   $ (2.25 )
     
     
     
     
     
 
Shares used in computing basic and diluted earnings (loss) per common share
    23,525       18,129       17,083       16,266       15,244  
Balance Sheet Data:
                                       
Working capital
  $ 7,554     $ 13,668     $ 17,266     $ 48,685     $ 39,766  
Total assets
    26,419       21,000       32,436       78,677       66,523  
Convertible preferred stock
          5,653                    
Total stockholders’ equity
    17,919       11,545       27,529       75,130       62,894  
Stockholders’ equity per common share
    0.62       0.56       1.57       4.41       4.10  


(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.
 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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, ZixChargeTM, 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

 
Continuing Operations
 
Revenues

      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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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.

      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

      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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executive management team. Further, these certificates were not a component of the Company’s product set, and their write-off had no effect on future operations.

      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 SysTrustTM 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

      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

      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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services capabilities. In late 2002, the Company began expanding its marketing reach into the healthcare community by adding personnel to the sales organization. Non-cash charges between 2001 and 2002 decreased by $5,698,000 primarily due to a decrease in stock-based compensation related to stock option grants for employees and third party service providers of $7,886,000, partially offset by $1,935,000 of non-recurring costs in 2002 related to Yahoo! Inc. and a non-recurring reduction in expenses in 2001 of $1,101,000 related to Anacom, which ceased operations in June 2001.

      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 and Other Income

      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

      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 Gains (Losses) on Investments

      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

      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.

 
Loss from Continuing Operations

      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.

 
Discontinued Operations

      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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Company anticipates further losses in 2004 and the utilization of cash resources for operating activities continues at a substantial level. To complement and expand our business and product offerings, the Company acquired the assets and the businesses of PocketScript, Elron Software and MyDocOnline in July 2003, September 2003 and January 2004, respectively, in exchange for certain equity securities of the Company. While no significant cash was required to make these acquisitions, each of these businesses have incurred operating losses in recent years. The Company expects to significantly and quickly reduce the substantial historical operating losses of MyDocOnline based upon a reduced number of employees and contractors, strategic expense cuts, expected increases in sales volumes and anticipated cost synergies with its existing businesses. See Notes 2 and 15 to the consolidated financial statements included herein.

      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:

                                                 
Payments Due by Period

Contractual Obligations 2004 2005 2006 2007 2008 Thereafter







Operating leases
  $ 1,143,000     $ 1,055,000     $ 867,000     $ 844,000     $ 844,000     $ 1,291,000  
Purchase obligations
    476,000       68,000       67,000                    
     
     
     
     
     
     
 
Total contractual obligations
  $ 1,619,000     $ 1,123,000     $ 934,000     $ 844,000     $ 844,000     $ 1,291,000  
     
     
     
     
     
     
 

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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.

 
Long-Lived Assets and Goodwill

      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.

 
Deferred Tax Assets

      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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Revenue Recognition

      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.

 
Business Acquisitions

      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

 
We continue to use significant amounts of cash.

      Since 1999, we have been developing and marketing products and services that bring privacy, security and convenience to Internet users, 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.

 
Our recent acquisitions of three companies may require us to invest significant resources to make them successful.

      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.

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

      We must be able to achieve broad market acceptance for our products and services in order to operate profitably. We have not yet been able to do this. To our knowledge, there are currently no secure e-messaging 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.

 
Competition in our businesses is expected to increase, which could cause our business — including the business of our recently acquired subsidiaries — to fail.

      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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services by adding a new feature set to our anti-virus, anti-spam and email content filtering services while expanding our offering to include URL filtering. Our PocketScript and MyDocOnline businesses are targeted toward the emerging markets for electronic prescriptions and online communication among the healthcare community. As the public’s and governmental authorities’ awareness about the need for privacy and security of electronic communications has increased over the past few years, an increasing number of competitors have entered the market.

      Although 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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specific health information to patients. Connect competitors include Medem, Inc., RelayHealth Corporation and MedFusion, Inc. with respect to the communication features, and WebMD Corporation with respect to the content resources. We believe that Connect offers superior services in the online doctor visit arena with the comprehensiveness of the templates; its ability to intelligently evaluate symptoms, interface with electronic medical records, control template availability at a granular level, and enable patients to include their health history; and its compatibility with the vast number of business/financial arrangements that exist in the healthcare industry. 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.

      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.

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

      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.

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

      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.

 
If health care providers fail to adopt the PocketScript and MyDocOnline Care Delivery Solutions, we will fail to achieve the critical mass of physicians and patients to build a successful 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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PocketScript and MyDocOnline services is dependent, in large measure, on physicians and other healthcare providers changing the manner in which they conduct their medical practices by beginning to use secure wireless and Internet communications channels to communicate with their patients, medical laboratories, payors, drug formularies, and others. Our challenge is to make these new businesses profitable. To do so may require us to invest significant resources, including significant amounts of cash, and there are no assurances that these businesses will become profitable in the near term.
 
Capacity limits on our technology and network hardware and software may be difficult to project, and we may not be able to expand and upgrade our systems to meet increased use, which would result in reduced revenues.

      While we have ample through-put capacity to handle our customers’ requirements for the medium term, at some point we may be required to expand and upgrade our technology and network hardware and software. We may not be able to accurately project the rate of increase in usage on our network, 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.

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

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

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

 
Defects or errors could affect the performance of our products and services.

      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.

 
Public key cryptography technology is subject to risks.

      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 key personnel.

      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.

 
We could be affected by government regulation.

      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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encryption products, such as our products. Failure to obtain the required governmental approvals would preclude the sale or use of our products in international markets.

      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.

 
Our stock price may be volatile.

      The market price of our common stock has fluctuated significantly in the past and is likely to fluctuate in the future. 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 own a substantial percentage of our securities. Their ownership could allow them to exercise significant control over corporate decisions and to implement corporate acts that are not in the best interests of our shareholders as a group.

      Our directors and executive officers beneficially own shares of our securities that represent approximately 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.

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

      George W. Haywood, a private investor, beneficially owns approximately 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.

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

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

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

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

      There are no assurances that we will be successful or that we will not encounter other, and even unanticipated, risks. We discuss other operating, financial or legal risks or uncertainties in our periodic filings with the 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.

 
Item 7A. Quantitative and Qualitative Disclosures About Market Risk

      The Company does not believe that it faces material market risk with respect to its cash investments and marketable securities, which totaled $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.

 
Item 8. Financial Statements and Supplementary Data

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

 
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures

      None.

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Item 9A. Controls and Procedures

      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

 
Item 10. Directors and Executive Officers of the Registrant

      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.

 
Item 11. Executive Compensation

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

 
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

      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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Item 13. Certain Relationships and Related Transactions

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

 
Item 14. Principal Accountant Fees and Services

      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

 
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K

      (a)(1) Financial Statements

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

      (a)(2) Financial Statement Schedules

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

      (a)(3) Exhibits

             
Exhibit
Number Description


  2 .1     Asset Purchase Agreement, dated July 22, 2003, between Zix Corporation and Pocket Script L.L.C. (excluding schedules and exhibits). Filed as Exhibit 4.1 to Zix Corporation’s Form 8-K, dated July 23, 2003, and incorporated herein by reference.
  2 .2     Asset Purchase Agreement, dated September 2, 2003, among Zix Corporation, Zix Acquisition Corporation, Elron Software, Inc., Elron Electronic Industries, Ltd., and Elron Software (2000), Ltd. (excluding schedules and exhibits). Filed as Exhibit 4.1 to Zix Corporation’s Form 8-K, dated September 4, 2003, and incorporated herein by reference.
  2 .3     Asset Purchase Agreement, dated as of January 30, 2004, by and among Zix Corporation, MyDocOnline, Inc., Aventis Pharmaceuticals Holdings Inc., and Aventis Pharmaceuticals Inc. (excluding schedules and exhibits). Filed as Exhibit 2.1 to Zix Corporation’s Form 8-K, dated February 10, 2004, and incorporated herein by reference.
  3 .1     Articles of Amendment to the Articles of Incorporation of Zix Corporation, as filed with the Texas Secretary of State on August 1, 2002. Filed as Exhibit 3.1 to Zix Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2002, and incorporated herein by reference. Restated Articles of Incorporation of Zix Corporation, as filed with the Texas Secretary of State on December 4, 2001. Filed as Exhibit 3.1 to Zix Corporation’s Annual Report on Form 10-K for the year ended December 31, 2001, and incorporated herein by reference.
  3 .2     Restated Bylaws of Zix Corporation, dated October 30, 2002. Filed as Exhibit 3.2 to Zix Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2002, and incorporated herein by reference.
  4 .1     Specimen certificate for common stock of Zix Corporation. Filed as Exhibit 4.1 to Zix Corporation’s Annual Report on Form 10-K for the year ended December 31, 1999, and incorporated herein by reference.

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Exhibit
Number Description


  4 .2     Form of Common Stock Warrant Certificate. Filed as Exhibit 4.1 in Zix Corporation’s Registration Statement on Form S-3 (Commission No. 333-83934), dated March 7, 2002, and incorporated herein by reference.
  4 .3     Form of Warrant, dated September 18, 2002, to purchase shares of common stock of Zix Corporation, issued by Zix Corporation. Filed as Exhibit 4.2 to Zix Corporation’s Form 8-K, dated September 20, 2002, and incorporated herein by reference.
  4 .4     Form of Warrant, dated September 18, 2002, to purchase shares of common stock of Zix Corporation, issued by Zix Corporation. Filed as Exhibit 4.6 to Zix Corporation’s Form 8-K, dated September 20, 2002, and incorporated herein by reference.
  4 .5     Form of Warrant to purchase shares of common stock of Zix Corporation, issued by Zix Corporation. Filed as Exhibit 4.2 to Zix Corporation’s Form 8-K, dated March 4, 2003, and incorporated herein by reference.
  4 .6     Form of Warrant to purchase shares of common stock of Zix Corporation, issued by Zix Corporation. Filed as Exhibit 4.4 to Zix Corporation’s Form 8-K, dated February 10, 2004, and incorporated herein by reference.
  4 .7     Secured Promissory Note of Zix Corporation to Aventis Inc., dated January 30, 2004, in the original principal amount of $3,000,000. Filed as Exhibit 4.1 to Zix Corporation’s Form 8-K, dated February 10, 2004, and incorporated herein by reference.
  4 .8     Security Agreement, dated as of January 30, 2004, by and between Zix Corporation and Aventis Inc. Filed as Exhibit 4.3 to Zix Corporation’s Form 8-K, dated February 10, 2004, and incorporated herein by reference.
  4 .9     Registration Rights Agreement, dated September 16, 2002, by and among Zix Corporation and the Investors named therein. Filed as Exhibit 4.3 to Zix Corporation’s Form 8-K, dated September 20, 2002, and incorporated herein by reference.
  4 .10     Registration Rights Agreement, dated September 17, 2002, by and among Zix Corporation and the Buyers named therein. Filed as Exhibit 4.7 to Zix Corporation’s Form 8-K, dated September 20, 2002, and incorporated herein by reference.
  4 .11     Registration Rights Agreement, dated July 22, 2003, between Zix Corporation and Pocket Script, L.L.C. Filed as Exhibit 4.2 to Zix Corporation’s Form 8-K, dated July 23, 2003, and incorporated herein by reference.
  4 .12     Registration Rights Agreement, dated September 2, 2003, between Zix Corporation and Elron Software, Inc. Filed as Exhibit 4.3 to Zix Corporation’s Form 8-K, dated September 4, 2003, and incorporated herein by reference.
  4 .13     Registration Rights Agreement, dated January 30, 2004, among Zix Corporation, Aventis Inc., and Aventis Holdings Inc. Filed as Exhibit 4.2 to Zix Corporation’s Form 8-K, dated February 10, 2004, and incorporated herein by reference.
  10 .1†     1990 Stock Option Plan of Zix Corporation (Amended and Restated as of September 1999). Filed as Exhibit 10.1 to Zix Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1999, and incorporated herein by reference.
  10 .2*†     1992 Stock Option Plan of Zix Corporation (Amended and Restated as of August 2000).
  10 .3†     1995 Long-Term Incentive Plan of Zix Corporation (Amended and Restated as of September 20, 2000). Filed as Exhibit 10.3 to Zix Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2000, and incorporated herein by reference.
  10 .4†     1996 Employee Stock Purchase Plan of Zix Corporation (Amended and Restated as of July 1, 2000). Filed as Exhibit 10.2 to Zix Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2000, and incorporated herein by reference.

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Exhibit
Number Description


  10 .5†     Zix Corporation’s 1999 Directors’ Stock Option Plan (Amended and Restated as of August 1, 2002). Filed as Exhibit 10.1 to Zix Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2002, and incorporated herein by reference.
  10 .6†     Zix Corporation’s 2001 Employee Stock Option Plan, dated May 4, 2001. Filed as Exhibit 10.1 to Zix Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2001, and incorporated herein by reference.
  10 .7*†     Zix Corporation’s 2001 Stock Option Plan (Amended and Restated as of May 6, 2003)
  10 .8†     Zix Corporation’s 2003 Stock Compensation Plan (Amended and Restated in October 2003). Filed as Exhibit 10.1 to Zix Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2003, and incorporated herein by reference.
  10 .9*†     Zix Corporation’s 2003 New Employee Stock Option Plan, dated October 1, 2003.
  10 .10*     Zix Corporation 401(k) Retirement Plan.
  10 .11*     Adoption Agreement relating to Zix Corporation 401(k) Retirement Plan.
  10 .12†     Stock Option Agreement, effective as of November 14, 2001, between John Ryan and Zix Corporation. Filed as Exhibit 4.2 in Zix Corporation’s Registration Statement on Form S-8 (Commission No. 333-74890), dated December 11, 2001, and incorporated herein by reference. Portions of this exhibit were omitted pursuant to a request for confidential treatment that was filed with the SEC on November 26, 2001. On December 5, 2001, the SEC approved the filing of this exhibit omitting the portions for which confidential treatment was requested. The omitted information has been filed with the SEC.
  10 .13†     Employment Agreement, effective as of November 14, 2001, between John Ryan and Zix Corporation. Filed as Exhibit 4.1 in Zix Corporation’s Registration Statement on Form S-8 (Commission No. 333-74890), dated December 11, 2001, and incorporated herein by reference.
  10 .14*†     Employment Agreement, entered into as of January 20, 2004, between Zix Corporation and Richard Spurr.
  10 .15*†     Stock Option Agreement, dated February 24, 2004, between Zix Corporation and Richard Spurr.
  10 .16*†     Employment Agreement, dated December 1, 2003, between Zix Corporation and Daniel S. Nutkis.
  10 .17*†     Stock Option Agreement, dated December 18, 2003, between Zix Corporation and Daniel S. Nutkis.
  10 .18*†     Stock Option Agreement, dated December 18, 2003, between Zix Corporation and Brad Almond.
  10 .19†     Severance Agreement, dated February 25, 2002, between Zix Corporation and Steve M. York. Filed as Exhibit 10.17 to Zix Corporation’s Annual Report on Form 10-K for the year ended December 31, 2001, and incorporated herein by reference.
  10 .20†     Severance Agreement, dated February 25, 2002, between Zix Corporation and Ronald A. Woessner. Filed as Exhibit 10.18 to Zix Corporation’s Annual Report on Form 10-K for the year ended December 31, 2001, and incorporated herein by reference.
  10 .21†     Form of Severance Agreement between Zix Corporation and Brad Almond, Dennis Heathcote, Dan Nutkis, and David Robertson. Filed as Exhibit 10.2 to Zix Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2002, and incorporated herein by reference.

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Exhibit
Number Description


  10 .22     Sublease Agreement, dated February 12, 1999, between Fidelity Corporate Real Estate, L.L.C. and Custom Tracks Operating Corporation. Filed as Exhibit 10.13 to Zix Corporation’s Annual Report on Form 10-K for the year ended December 31, 1998, and incorporated herein by reference.
  10 .23     Sublease Agreement, dated May 8, 2000, between Rosewood Resources, Inc. and Zix Corporation. Filed as Exhibit 10.1 to Zix Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2000, and incorporated herein by reference.
  10 .24*     Lease Agreement, dated December 29, 2003, between Zix Corporation and 7-Eleven, Inc. (excluding exhibits).
  10 .25*     Sublease for space at 67 South Bedford Street, Burlington, Massachusetts, dated June 24, 2003, by and between Elron Software, Inc. and Cognos Corporation and related Addendums I and II (excluding exhibit and attachment).
  10 .26*     Hawkston Hall Office Centre Lease Agreement, dated October 17, 2001 (and as amended) between Elron Software, Inc. and Saratoga Partners, Ltd.
  10 .27*     Lease Agreement, dated November 27, 2000, between MyDocOnline, Inc. and Ft. Round Rock Ltd. and related Amendments No. 1 and No. 2 (excluding exhibits).
  10 .28*     Sublease Agreement, dated as of July 31, 2002, between MyDocOnline, Inc. and Cybear, Inc.
  10 .29     Sublease Agreement, dated August 1, 2002, between Zix Corporation, Optiwave Corporation and Waidt Construction & Developments LTD (excluding schedules and exhibits). Filed as Exhibit 10.23 to Zix Corporation’s Annual Report on Form 10-K for the year ended December 31, 2002, and incorporated herein by reference.
  10 .30     Sublease Amendment Agreement, dated September 30, 2002, between Zix Corporation, Optiwave Corporation and Waidt Construction & Developments LTD (excluding exhibits). Filed as Exhibit 10.24 to Zix Corporation’s Annual Report on Form 10-K for the year ended December 31, 2002, and incorporated herein by reference.
  10 .31     Sublease Amendment Agreement, dated November 19, 2002, between Zix Corporation, Optiwave Corporation and Waidt Construction & Developments LTD (excluding exhibits). Filed as Exhibit 10.25 to Zix Corporation’s Annual Report on Form 10-K for the year ended December 31, 2002, and incorporated herein by reference.
  10 .32*     Sublease Amendment Agreement, dated July 17, 2003, between Zix Corporation, Optiwave Corporation and Waidt Construction & Developments LTD (excluding exhibits).
  10 .33*     Facilities Service Agreement, entered into as of June 25, 2003, by and between Collocation Solutions, LLC and Zix Corporation (excluding schedule and exhibit).
  10 .34*     Lease, dated March 9, 2004, between Duke Realty Ohio and PocketScript, Inc. (excluding exhibits).
  10 .35     Master Services Agreement, dated January 30, 2004, by and between Zix Corporation and Aventis Inc. Filed as Exhibit 10.1 to Zix Corporation’s Form 8-K, dated February 10, 2004, and incorporated herein by reference. Portions of this exhibit were omitted and filed separately with the Commission pursuant to a request for confidential treatment filed with the Commission.
  21 .1*     Subsidiaries of Zix Corporation.
  23 .1*     Consent of Independent Auditors.
  31 .1*     Certification of John A. Ryan, Chairman and Chief Executive Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31 .2*     Certification of Steve M. York, Chief Financial Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

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Exhibit
Number Description


  32 .1*     Certification of John A. Ryan, Chairman and Chief Executive Officer of the Company, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32 .2*     Certification of Steve M. York, Chief Financial Officer of the Company, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


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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Table of Contents

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.

         
Signature Title


 
/s/ JOHN A. RYAN

(John A. Ryan)
  Chairman, Chief Executive Officer and Director (Principal Executive Officer)
 
/s/ STEVE M. YORK

(Steve M. York)
  Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)
 
/s/ MICHAEL E. KEANE

(Michael E. Keane)
  Director
 
/s/ JAMES S. MARSTON

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

(Antonio R. Sanchez III)
  Director
 
/s/ DR. BEN G. STREETMAN

(Dr. Ben G. Streetman)
  Director

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

         
Report of Independent Auditors
    F-2  
Consolidated Balance Sheets at December 31, 2003 and 2002
    F-3  
Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and 2001
    F-4  
Consolidated Statements of Convertible Preferred Stock and Stockholders’ Equity for the years ended December 31, 2003, 2002 and 2001
    F-5  
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001
    F-6  
Notes to Consolidated Financial Statements
    F-7  

F-1


Table of Contents

REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Stockholders

Zix Corporation

      We have audited the accompanying consolidated balance sheets of Zix Corporation as of December 31, 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

March 12, 2004

F-2


Table of Contents

ZIX CORPORATION

CONSOLIDATED BALANCE SHEETS

                     
December 31,

2003 2002


ASSETS
Current assets:
               
 
Cash and cash equivalents
  $ 6,599,000     $ 7,586,000  
 
Marketable securities
    7,253,000       7,246,000  
 
Receivables, net
    359,000       1,014,000  
 
Other current assets
    1,147,000       1,546,000  
     
     
 
   
Total current assets
    15,358,000       17,392,000  
Property and equipment, net
    3,151,000       3,608,000  
Intangible assets, net
    3,589,000        
Goodwill
    4,321,000        
     
     
 
    $ 26,419,000     $ 21,000,000  
     
     
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
 
Accounts payable and accrued expenses
  $ 3,738,000     $ 2,976,000  
 
Deferred revenue
    4,066,000       748,000  
     
     
 
   
Total current liabilities
    7,804,000       3,724,000  
Deferred revenue — noncurrent
    696,000       78,000  
Commitments and contingencies
               
Convertible preferred stock:
               
 
Series A convertible preferred stock, $1 par value, 819,886 shares authorized; none issued and outstanding in 2003 and 765,559 issued and outstanding in 2002
          2,252,000  
 
Series B convertible preferred stock, $1 par value, 1,304,815 shares authorized; none issued and outstanding in 2003 and 1,246,715 issued and outstanding in 2002
          3,401,000  
     
     
 
            5,653,000  
Stockholders’ equity:
               
 
Preferred stock, $1 par value, 7,875,299 shares authorized; none issued and outstanding
           
 
Common stock, $0.01 par value, 175,000,000 shares authorized; 31,155,646 issued and 28,828,465 outstanding in 2003 and 22,764,798 issued and 20,437,617 outstanding in 2002
    312,000       228,000  
 
Additional capital
    230,580,000       195,846,000  
 
Unearned stock-based compensation
    (26,000 )     (565,000 )
 
Treasury stock, at cost; 2,327,181 common shares
    (11,507,000 )     (11,507,000 )
 
Accumulated deficit
    (201,440,000 )     (172,457,000 )
     
     
 
   
Total stockholders’ equity
    17,919,000       11,545,000  
     
     
 
    $ 26,419,000     $ 21,000,000  
     
     
 

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

F-3


Table of Contents

ZIX CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

                           
Year Ended December 31,

2003 2002 2001



Revenues:
                       
 
Services
  $ 5,134,000     $ 1,672,000     $ 317,000  
 
Software sales
    706,000              
     
     
     
 
      5,840,000       1,672,000       317,000  
Cost of revenues
    (8,211,000 )     (8,999,000 )     (14,996,000 )
Research and development expenses
    (5,896,000 )     (6,180,000 )     (9,019,000 )
Selling, general and administrative expenses
    (19,907,000 )     (19,335,000 )     (29,892,000 )
Investment and other income
    138,000       319,000       2,187,000  
Interest expense
    (13,000 )     (2,141,000 )      
Realized and unrealized gains (losses) on investments
    530,000       96,000       (5,391,000 )
     
     
     
 
Loss from continuing operations before income taxes
    (27,519,000 )     (34,568,000 )     (56,794,000 )
Income taxes
    (148,000 )     269,000        
     
     
     
 
Loss from continuing operations
    (27,667,000 )     (34,299,000 )     (56,794,000 )
Discontinued operations
    89,000       862,000       48,000  
     
     
     
 
Net loss
  $ (27,578,000 )   $ (33,437,000 )   $ (56,746,000 )
     
     
     
 
Basic and diluted earnings (loss) per common share:
                       
 
Continuing operations
  $ (1.23 )   $ (2.07 )   $ (3.32 )
 
Discontinued operations
          0.05        
     
     
     
 
 
Net loss
  $ (1.23 )   $ (2.02 )   $ (3.32 )
     
     
     
 
Weighted average common shares outstanding
    23,525,077       18,128,796       17,083,037  
     
     
     
 

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

F-4


Table of Contents

ZIX CORPORATION

CONSOLIDATED STATEMENTS OF CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY

                                                                                   
Stockholders’ Equity

Convertible Preferred Accumulated
Stock Common Stock Unearned Other Total


Additional Stock-Based Treasury Comprehensive Accumulated Stockholders’
Shares Amount Shares Amount Capital Compensation Stock Loss Deficit Equity










Balance, December 31, 2000
        $       19,327,563     $ 193,000     $ 180,128,000     $ (14,615,000 )   $ (11,314,000 )   $ (169,000 )   $ (79,093,000 )   $ 75,130,000  
 
Exercise of stock options for cash
                27,500             222,000                               222,000  
 
Unearned employee stock- based compensation
                152,672       2,000       973,000       (975,000 )                        
 
Unearned stock-based compensation for service providers
                            49,000       (49,000 )                        
 
Cancellation of agreement to issue stock for purchase of Anacom Communications
                            (4,725,000 )     4,725,000                          
 
Amortization of unearned stock-based compensation
                                  8,378,000                         8,378,000  
 
Common stock issued to Entrust
                353,383       4,000       396,000                               400,000  
 
Other
                            76,000             (100,000 )                 (24,000 )
 
Comprehensive net loss:
                                                                               
 
Net loss
                                                    (56,746,000 )     (56,746,000 )
 
Realized loss on marketable securities
                                              169,000             169,000  
                                                                             
 
 
Comprehensive net loss
                                                          (56,577,000 )
     
     
     
     
     
     
     
     
     
     
 
Balance, December 31, 2001
                19,861,118       199,000       177,119,000       (2,536,000 )     (11,414,000 )           (135,839,000 )     27,529,000  
 
Common stock issued to Tumbleweed for patents
                116,833       1,000       761,000                               762,000  
 
Common stock issued to Yahoo! for services
                468,514       5,000       2,530,000                               2,535,000  
 
Common stock issued to former employees in lieu of severance
                68,622       1,000       173,000                               174,000  
 
Series A convertible preferred stock issued for cash, net of issuance costs
    819,886       2,184,000                                                  
 
Warrants related to Series A convertible preferred stock issued for cash, net of issuance costs
                            964,000                               964,000  
 
Series A convertible preferred stock converted into common stock
    (54,327 )     (145,000 )     51,690             145,000                               145,000  
 
Series B convertible preferred stock issued for cash, net of issuance costs
    1,304,815       3,213,000                                                  
 
Warrants related to Series B convertible preferred stock issued for cash, net of issuance costs
                            1,420,000                               1,420,000  
 
Series B convertible preferred stock converted into common stock
    (58,100 )     (156,000 )     56,210       1,000       155,000                               156,000  
 
Dividends on Series A and Series B convertible preferred stock
          557,000                   2,624,000                         (3,181,000 )     (557,000 )
 
Beneficial conversion feature resulting from the issuance of convertible notes payable
                            1,698,000                               1,698,000  
 
Warrants related to convertible notes payable issued for cash, net of issuance costs
                            1,113,000                               1,113,000  
 
Convertible notes payable converted into common stock
                2,141,811       21,000       6,744,000                               6,765,000  
 
Unearned stock-based compensation for service providers
                            333,000       (333,000 )                        
 
Amortization of unearned stock-based compensation
                                  2,304,000                         2,304,000  
 
Other
                            67,000             (93,000 )                 (26,000 )
 
Net loss
                                                    (33,437,000 )     (33,437,000 )
     
     
     
     
     
     
     
     
     
     
 
Balance, December 31, 2002
    2,012,274       5,653,000       22,764,798       228,000       195,846,000       (565,000 )     (11,507,000 )           (172,457,000 )     11,545,000  
 
Exercise of stock options and warrants for cash
                2,358,968       23,000       12,942,000                               12,965,000  
 
Series A convertible preferred stock converted into common stock
    (765,559 )     (2,814,000 )     787,424       8,000       2,806,000                               2,814,000  
 
Series B convertible preferred stock converted into common stock
    (1,246,715 )     (4,244,000 )     1,271,653       13,000       4,231,000                               4,244,000  
 
Dividends on Series A and Series B convertible preferred stock
          1,405,000                                           (1,405,000 )     (1,405,000 )
 
Common stock and related warrants issued for cash in private placements, net of issuance costs
                1,566,758       16,000       5,592,000                               5,608,000  
 
Common stock issued for purchase of PocketScript
                362,903       3,000       1,383,000                               1,386,000  
 
Common stock issued for purchase of Elron Software
                1,709,402       17,000       6,316,000                               6,333,000  
 
Promissory note payable converted into common stock
                262,454       3,000       1,010,000                                       1,013,000  
 
Common stock issued in lieu of cash compensation
                71,286       1,000       483,000                               484,000  
 
Unearned stock-based compensation for service providers
                            11,000       (11,000 )                        
 
Amortization of unearned stock-based compensation
                                  550,000                         550,000  
 
Other
                            (40,000 )                             (40,000 )
 
Net loss
                                                    (27,578,000 )     (27,578,000 )
     
     
     
     
     
     
     
     
     
     
 
Balance, December 31, 2003
        $       31,155,646     $ 312,000     $ 230,580,000     $ (26,000 )   $ (11,507,000 )   $     $ (201,440,000 )   $ 17,919,000  
     
     
     
     
     
     
     
     
     
     
 

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

F-5


Table of Contents

ZIX CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

                                 
Year Ended December 31,

2003 2002 2001



Cash flows from operating activities:
                       
 
Loss from continuing operations
  $ (27,667,000 )   $ (34,299,000 )   $ (56,794,000 )
 
Adjustments to reconcile loss from continuing operations to net cash used by operating activities:
                       
   
Depreciation and amortization
    3,676,000       7,500,000       10,799,000  
   
Stock-based compensation
    550,000       2,478,000       8,378,000  
   
Common stock issued in lieu of cash compensation
    484,000              
   
Stock issued to Tumbleweed for patents
          762,000        
   
Stock issued to Yahoo! for services
          1,935,000        
   
Beneficial conversion feature resulting from the issuance of convertible notes payable
          1,698,000        
   
Amortization of issuance discount on convertible notes payable
          368,000        
   
Loss on Lante Corporation common stock
                391,000  
   
Write-off (recovery) of investment in Maptuit Corporation
    (530,000 )           5,000,000  
   
Write-off of digital identification certificates
                3,000,000  
   
Other non-cash expenses
    13,000             733,000  
   
Changes in assets and liabilities, excluding acquisitions of businesses:
                       
     
Other assets
    1,640,000       (476,000 )     (193,000 )
     
Liabilities
    3,089,000       275,000       1,671,000  
     
     
     
 
   
Net cash used by continuing operations
    (18,745,000 )     (19,759,000 )     (27,015,000 )
   
Net cash provided (used) by discontinued operations
    (36,000 )     81,000       (12,000 )
     
     
     
 
       
Net cash used by operating activities
    (18,781,000 )     (19,678,000 )     (27,027,000 )
Cash flows from investing activities:
                       
 
Purchases of property and equipment, net
    (2,252,000 )     (845,000 )     (1,174,000 )
 
Purchases of marketable securities
    (11,951,000 )     (19,894,000 )     (23,642,000 )
 
Sales and maturities of marketable securities
    11,944,000       23,856,000       49,155,000  
 
Recovery from (investment in) Maptuit Corporation
    530,000             (2,000,000 )
 
Purchase of PocketScript
    (50,000 )            
 
Cash acquired in the purchase of Elron Software
    1,000,000              
     
     
     
 
       
Net cash provided (used) by investing activities
    (779,000 )     3,117,000       22,339,000  
Cash flows from financing activities:
                       
 
Proceeds from exercise of stock options or warrants
    12,965,000             222,000  
 
Proceeds from private placement of common stock and related warrants, net of issuance costs
    5,608,000              
 
Proceeds from private placement of convertible notes payable and related warrants, net of issuance costs
          7,509,000        
 
Proceeds from private placement of convertible preferred stock and related warrants, net of issuance costs
          7,781,000        
     
     
     
 
       
Net cash provided by financing activities
    18,573,000       15,290,000       222,000  
Effect of exchange rate changes on cash and cash equivalents
                (24,000 )
     
     
     
 
Decrease in cash and cash equivalents
    (987,000 )     (1,271,000 )     (4,490,000 )
Cash and cash equivalents, beginning of year
    7,586,000       8,857,000       13,347,000  
     
     
     
 
Cash and cash equivalents, end of year
  $ 6,599,000     $ 7,586,000     $ 8,857,000  
     
     
     
 
Supplemental cash flow information:
                       
 
Income tax refund
  $     $ 499,000     $  

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

F-6


Table of Contents

ZIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
1. Basis of Presentation and Summary of Significant Accounting Policies
 
The Company

      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 1999, the Company began developing and marketing products and services that bring privacy, security and convenience to Internet users. ZixMail® is a desktop solution for encrypting and securely delivering email. The Company did not begin to charge for the use of ZixMail until the first quarter of 2001. In 2002, the Company began offering additional products. ZixVPM® (Virtual Private Messenger) is an e-messaging gateway solution that provides company-wide privacy protection for inbound and outbound email communications. ZixAuditor® is an assessment service used to analyze email traffic patterns and monitor compliance with corporate and regulatory policies. ZixPortTM provides a secure Web-messaging portal. In 2003, the Company introduced ZixWorksTM, a suite of fully managed hosted services that enables users to send email securely and that protects organizations from viruses, spam, inappropriate content and electronic attack.

      In July 2003, the Company acquired substantially all of the operating assets and the business of 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.

      In September 2003, the Company acquired substantially all of the operating assets and the business of Elron Software, Inc., (“Elron Software”), 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 feature set to its anti-spam, anti-virus, and email content filtering services while expanding its offerings to include Web filtering. All of these solutions can now be offered on-premise, fully hosted, or co-sourced (meaning a shared service offering).

      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. At December 31, 2003, the Company’s cash and marketable securities totaled $13,852,000. The Company’s future cash requirements depend primarily on the timing and magnitude of cash flows generated from new customer orders. Cash flows will also be impacted by capital expenditure requirements, resources devoted to the additional development of products and services and resources devoted to sales and marketing. In the future, the Company may need to raise additional funds to sustain its operations or initiate reductions in operating expenses, or both.

      Consolidation — The consolidated financial statements of Zix Corporation include the accounts of its wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated.

      Use of estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management reviews its estimates on an ongoing basis, including

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ZIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

those related to the carrying value of long-lived assets and goodwill, and the valuation allowance for its U.S. deferred tax assets. Revisions to such estimates are based upon currently available facts and circumstances.

      Cash investments and marketable securities — Cash investments with maturities of three months or less when purchased are considered cash equivalents. Cash and cash equivalents at December 31, 2003 primarily consist of bank deposits, daily money market funds, commercial paper and asset-backed securities. Marketable securities, which are available-for-sale, are as follows:

                 
December 31, December 31,
2003 2002


Commercial paper
  $ 4,990,000     $ 1,989,000  
Asset-backed securities
    1,992,000        
U.S. government security
          4,989,000  
Certificate of deposit
    271,000       268,000  
     
     
 
    $ 7,253,000     $ 7,246,000  
     
     
 

      Marketable securities are carried at fair market value. Marketable securities held on December 31, 2003 mature on various dates through June 2004. Investment income includes income from cash investments and marketable securities totaling $138,000, $289,000 and $1,687,000 for the years 2003, 2002 and 2001, respectively.

      Depreciation and amortization — Property and equipment are recorded at cost and depreciated or amortized using the straight-line method over their estimated useful lives as follows: computer equipment and software — 3 years; leasehold improvements — 5 year primary lease term; and office equipment, furniture and fixtures — 5 years. Intangible assets, which were acquired in the third quarter of 2003 in connection with the acquisitions of PocketScript and Elron Software, are amortized using the straight-line method over their estimated useful lives of three or four years. Goodwill, which resulted from the acquisition of Elron Software, is not being amortized in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.” The Company periodically reviews its long-lived assets and goodwill for impairment or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable (Note 5).

      Revenue recognition — 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 prescription solutions are offered on a subscription basis. The Company’s subscription service includes delivering licensed software and providing customer support and secure electronic communications 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, email content filtering and Web filtering solutions 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

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ZIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

multiple element arrangements that include 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.

      Software development costs — Costs incurred in the development and testing of software used in the Company’s secure messaging and electronic prescription services related to research, project planning, training, maintenance and general and administrative activities, and overhead costs are expensed as incurred. The costs of relatively minor upgrades and enhancements to the software are also expensed as incurred. Certain costs incurred during development of these software applications, including costs of materials, services and payroll and payroll-related costs for employees directly associated with the development project, qualify for capitalization. Due to the uncertainty of the amount and timing of future net revenues to be generated from these services, all development costs incurred through December 31, 2003 related to such products have been expensed and are included in research and development expenses.

      Software development costs related to the development of the Company’s anti-spam, email content filtering and Web filtering products, which are sold to customers under perpetual license agreements, are expensed as incurred until technological feasibility has been established, at which time subsequent costs qualify for capitalization until the product is available for general release to customers. To date, the costs incurred subsequent to the achievement of technological feasibility have not been material. As a result, software development costs qualifying for capitalization related to these products have been expensed and are included in research and development expenses.

      Advertising expense — Advertising costs are expensed as incurred and totaled $1,400,000 in 2003, $2,898,000 in 2002 and $4,452,000 in 2001.

      Stock-based employee compensation — At December 31, 2003, the Company had various stock-based compensation plans covering employees and directors as more fully described in Note 6. As permitted by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), the Company accounts for stock-based compensation plans under the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related interpretations. Compensation expense for employee stock options, if any, is measured as the excess of the quoted market price of the Company’s stock at the date of grant over the amount an employee must pay to acquire the stock. SFAS 123 encourages adoption of a fair-value based method for valuing the cost of stock-based compensation; however, it allows companies to continue to use the intrinsic value method under APB 25 and disclose pro forma results and earnings per share in accordance with SFAS 123. Under SFAS 123, compensation cost is measured at the grant date based upon the value of the award and is recognized over the vesting period. Because the Company’s stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions to the option valuation models can materially affect their estimated fair value, in management’s opinion, the existing valuation methods do not necessarily provide a reliable single measure of the fair value of its stock options. Had compensation cost for

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ZIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

the Company’s stock-based compensation been determined consistent with SFAS 123, the Company’s net loss and loss per common share would have been as follows:

                         
2003 2002 2001



Net loss, as reported
  $ (27,578,000 )   $ (33,437,000 )   $ (56,746,000 )
Add stock compensation expense recorded under the intrinsic value method
          1,590,000       9,047,000  
Less pro forma stock compensation expense computed under the fair value method
    (4,502,000 )     (3,174,000 )     (19,672,000 )
     
     
     
 
Pro forma net loss
  $ (32,080,000 )   $ (35,021,000 )   $ (67,371,000 )
     
     
     
 
Basic and diluted pro forma loss per common share
  $ (1.42 )   $ (2.11 )   $ (3.94 )
     
     
     
 

      The Company used the Black-Scholes option pricing model to determine the fair value of grants made during 2003, 2002 and 2001. The following weighted average assumptions were applied in determining the pro forma compensation cost:

                           
2003 2002 2001



Risk-free interest rate
    1.77%       2.56%       3.85%  
Expected option life
    2.5 years       2.7 years       2.7 years  
Expected stock price volatility
    103%       129%       138%  
Expected dividend yield
                 
Fair value of options:
                       
 
Granted at market price
  $ 2.63     $ 3.18     $ 5.74  
 
Granted at prices exceeding market
              $ 3.49  
 
Granted at prices less than market
              $ 7.61  

      Earnings per share — The amounts presented for basic and diluted loss per common share in the accompanying consolidated statements of operations have been computed by dividing the losses applicable to common stock by the weighted average number of common shares outstanding. The two presentations are equal in amounts because the assumed exercise of common stock equivalents would be antidilutive, because a loss from continuing operations was reported for each period presented. 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 $1,405,000 and $3,181,000, respectively, representing the preferred stock dividends associated with the Series A and B convertible preferred stocks. The following table sets forth antidilutive securities which were outstanding at year-end which have been excluded from the computation of diluted earnings (loss) per common share:

                           
2003 2002 2001



Stock options
    6,048,217       6,624,739       6,837,341  
Warrants
    3,643,778       4,151,558       2,138,890  
Series A convertible preferred stock
          728,395        
Series B convertible preferred stock
          1,187,348        
     
     
     
 
 
Total antidilutive securities excluded
    9,691,995       12,692,040       8,976,231  
     
     
     
 

      Comprehensive income (loss) — Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income,” establishes standards for reporting comprehensive income (loss) and its components in the financial statements. Comprehensive income (loss), as defined, includes all changes in equity (net

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ZIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

assets) during a period from non-owner sources. In 2001, the difference between net loss and total comprehensive net loss was due to an unrealized loss on marketable securities in 2000 which was realized upon their sale in 2001.

      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.

      Reclassifications — Certain prior year amounts have been reclassified to conform with the 2003 presentation.

 
2. Business Acquisitions
 
Elron Software, Inc.

      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. Elron Software develops, markets, licenses, supports and maintains computer software products which provide anti-spam, email content filtering and Web filtering solutions. The consideration for the acquisition consisted of 1,709,402 shares of the Company’s 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 results of operations of Elron Software are included in the Company’s results of operations from the date of acquisition.

      The components of the aggregate cost of the acquisition are as follows:

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

      The fair market value of the Company’s common stock for financial accounting purposes was based on the five day average of the closing prices on the date of the acquisition and the two trading days before and after such date, discounted by $333,000 to account for certain contractual sale restrictions.

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ZIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The cost of the acquisition of Elron Software has been allocated to the assets and liabilities acquired, with the remainder recorded as goodwill, based on estimates of fair value as follows:

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

      The values for the acquired deferred revenue, developed technology, customer contracts and relationships and trademarks and trade names were determined by management, based on an independent valuation. The asset values were established by discounting the estimated projected net cash flows to be generated from the related assets. The rate used to discount the net cash flows to present value was 20%. Developed technology and trademarks and trade names are being amortized to expense on a straight-line basis over three years from the acquisition date. Customer contracts and relationships are being amortized to expense on a straight-line basis over four years from the acquisition date. Deferred revenue was recorded at its fair value on the acquisition date and is being amortized to revenues ratably over the remaining contractual maintenance periods. The acquired goodwill is deductible for tax purposes.

      The following unaudited pro forma information presents the Company’s results of operations as if the acquisition of Elron Software had occurred as of January 1, 2002. The pro forma information has been prepared by combining the results of operations of the Company and Elron Software, with adjustments to eliminate Elron Software’s historical expenses for stock compensation, amortization of intangibles and interest, and to record interest expense, amortization of intangibles and adjustments to recognized revenues resulting from the application of purchase accounting. The pro forma information does not purport to be indicative of what would have occurred had the acquisition occurred as of January 1, 2002, or the results of operations that may occur in the future.

                 
2003 2002


Revenues
  $ 10,466,000     $ 8,938,000  
     
     
 
Loss from continuing operations
  $ (31,955,000 )   $ (43,345,000 )
     
     
 
Basic and diluted loss per common share
  $ (1.35 )   $ (2.35 )
     
     
 

PocketScript, Inc.

      On July 22, 2003, the Company acquired substantially all of the operating assets and the business of PocketScript, a privately-held development stage enterprise which provides electronic prescription solutions for the healthcare industry. The results of operations of PocketScript are included in the Company’s results of operations from the date of acquisition. PocketScript’s historical operating results are insignificant compared to the Company’s historical operating results.

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ZIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The components of the aggregate cost of the acquisition are as follows:

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

      The fair market value of the Company’s common stock for financial accounting purposes was calculated using the five day average of the closing prices on the date of the acquisition and the two trading days before and after such date.

      The cost of the acquisition of PocketScript has been allocated to the assets and liabilities acquired based on management’s estimates of fair value as follows:

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

      Developed technology is being amortized to expense on a straight-line basis over three years from the acquisition date.

 
3. Receivables
                   
December 31, December 31,
2003 2002


Gross receivables
  $ 2,306,000     $ 2,065,000  
Allowance for doubtful accounts
    (93,000 )      
Deferred revenue
    (1,854,000 )     (1,051,000 )
     
     
 
 
Receivables, net
  $ 359,000     $ 1,014,000  
     
     
 

      The reduction for deferred revenue represents future customer service or maintenance obligations which have been billed to the customer but remain unpaid as of the dates indicated. Deferred revenue on the Company’s consolidated balance sheets represents future customer service or maintenance obligations which have been billed and collected as of the respective balance sheet dates.

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ZIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
4. Property and Equipment
                 
December 31, December 31,
2003 2002


Computer equipment and software
  $ 29,757,000     $ 27,082,000  
Leasehold improvements
    4,622,000       4,608,000  
Office equipment, furniture and fixtures
    1,084,000       1,040,000  
     
     
 
      35,463,000       32,730,000  
Less accumulated depreciation and amortization
    (32,312,000 )     (29,122,000 )
     
     
 
    $ 3,151,000     $ 3,608,000  
     
     
 

      The Company’s continuing operations include depreciation and amortization expense related to property and equipment of $3,228,000 in 2003, $7,500,000 in 2002 and $9,905,000 in 2001.

 
5. Intangible Assets and Goodwill

      At December 31, 2003, the Company’s intangible assets and goodwill were comprised of the following, which resulted from the third quarter 2003 acquisitions of PocketScript and Elron Software:

                             
December 31, 2003

Weighted Average Gross Carrying Accumulated
Useful Lives Amount, at Cost Amortization



Subject to amortization:
                       
 
Developed technology
    3 years     $ 2,269,000     $ 289,000  
 
Customer contracts and relationships
    4 years       1,336,000       111,000  
 
Trademarks and trade names
    3 years       432,000       48,000  
             
     
 
   
Intangible assets
          $ 4,037,000     $ 448,000  
             
     
 
Not subject to amortization:
                       
 
Goodwill
          $ 4,321,000     $  
             
     
 

      Amortization expense relating to intangible assets subject to amortization totaled $448,000 in 2003. The estimated amortization expense for each of the next four years is as follows:

         
2004
  $ 1,234,000  
2005
    1,234,000  
2006
    898,000  
2007
    223,000  

      The Company reviews its intangible assets for impairment, by comparing the carrying value of the asset with its estimated fair value, when changes in circumstances indicate that the carrying amount of an asset may not be recoverable. 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 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.

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ZIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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.

 
6. Convertible Preferred Stock and Stockholders’ Equity
 
Private Placement of Common Stock and Warrants

      In June 2003, the Company completed private placements whereby the Company received an aggregate of $5,750,000 in cash, excluding issuance costs of $142,000, in exchange for 1,566,758 shares of common stock and warrants to purchase 231,855 shares of common stock. The shares of common stock were sold at a price of $3.67 per share and the warrants have an exercise price of $4.96 per share. The warrants were exercisable when issued and expire in June 2007. At December 31, 2003, warrants to purchase 191,533 shares of the Company’s common stock were outstanding.

 
Private Placement of Convertible Equity Securities

      In September 2002, the Company completed private placements whereby the Company received an aggregate of $16,000,000 in cash in exchange for convertible notes, two separate series of convertible redeemable preferred stock and warrants to purchase the Company’s common stock.

 
Issuance and Conversion of Convertible Notes

      In September 2002, the Company issued $8,000,000 in Convertible Notes (“Notes”) with a coupon rate of 6.5% to institutional investors. As part of this placement, the noteholders received immediately exercisable warrants to purchase 386,473 shares of the Company’s common stock at a price per share of $4.14 for a period of three years. The noteholders had the right at any time to convert the Notes into shares of the Company’s common stock at a conversion price of $3.78 per share. In the fourth quarter of 2002, the noteholders converted the Notes and related accrued interest into 2,141,811 shares of the Company’s common stock, and the Company recorded an increase to common stock and additional capital equivalent to the carrying value of the converted debt. In April 2003, the Company and the former noteholders completed a warrant exercise and replacement program whereby the Company received $1,600,000 in cash as a result of the noteholders exercising their original warrants and issued replacement warrants to the noteholders to purchase 455,017 shares of the Company’s common stock at $5.00 per share. Subsequently, as a result of the Company’s private placement in June 2003, the Elron Software acquisition in September 2003, and certain anti-dilution provisions of the replacement warrants, the price per common share pursuant to these replacement warrants, all of which are outstanding on December 31, 2003, was reduced from $5.00 to $3.51 and the number of common shares available for purchase was increased from 455,017 to 648,172.

      Upon their issuance, the fair value of the warrants issued to the noteholders, aggregating $1,148,000 using the Black-Scholes option pricing model, was recorded as an increase to additional capital with an offsetting reduction in the carrying value of the Notes. From the date of issuance of the Notes until the dates of their conversion, the Company recognized non-cash interest expense of $368,000 from the amortization of the issuance discount. This issuance discount on the notes was being amortized, as interest expense, based upon the expected redemption dates of the Notes using the effective interest rate method, resulting in an effective interest rate of 29.5%, including the 6.5% interest coupon on the Notes. Separately, as a result of the significant issuance discount on the Notes, in the third quarter of 2002, the Company recorded a non-recurring, non-cash interest expense charge of $1,698,000, with an offsetting increase to additional capital, representing the beneficial conversion feature resulting from the Notes being convertible into shares of

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ZIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

common stock at an effective price less than the fair market value of the common stock on the date the Notes were issued. Upon completion of the conversion of the Notes into the Company’s common stock, the Company incurred an additional $250,000 of issuance costs which was recorded as a reduction to additional capital.

 
Issuance and Conversion/ Redemption of Series A Convertible Preferred Stock

      In September 2002, the Company received total proceeds of $3,250,000 in exchange for shares of a newly created Series A Convertible Preferred Stock (“Series A”) and warrants to purchase 288,244 shares of the Company’s common stock. The Series A accrued cumulative dividends at the rate of 6.5% per annum and were initially convertible into 780,085 shares of the Company’s common stock at $4.12 per share. The warrants to purchase shares of the Company’s common stock issued to the Series A investors have a current exercise price per share of $4.42 subject to anti-dilution adjustments, became exercisable in March 2003 and expire in September 2006. Series A investors were comprised of Antonio R. Sanchez, Jr., a former director and father of a current director, and a current beneficial owner of approximately 8.7% of the Company’s common stock, and related entities; John A. Ryan, the Company’s chairman and chief executive officer; and David P. Cook, founder of the Company, who invested $2,000,000, $750,000 and $500,000, respectively.

      In September 2002, $213,000 of Series A was voluntarily converted into 51,690 shares of the Company’s common stock and in January 2003, $281,000 of Series A was voluntarily converted into 68,323 shares of the Company’s common stock. In May, July and September of 2003, $315,000, $318,000 and $322,000 of Series A and related accrued dividends were redeemed by the Company as scheduled by issuing 80,405, 81,241 and 82,093 shares of the Company’s common stock, respectively. On September 30, 2003, after the Company’s common stock price closed above $6.18 for ten consecutive trading days, the Company elected to convert the remaining $1,935,000 of Series A and related accrued dividends into 475,362 shares of the Company’s common stock at $4.07 per share. At December 31, 2003, warrants to purchase 243,899 shares of the Company’s common stock were outstanding.

      Upon their issuance, the fair value of the warrants issued to the Series A investors, aggregating $960,000 using the Black-Scholes option pricing model, was recorded as an increase to additional capital with an offsetting reduction in the carrying value of the Series A. The carrying value of the Series A was being accreted, as preferred stock dividends, to their redemption value plus accrued dividends at 6.5% based upon their expected redemption dates using the effective interest rate method, resulting in an effective dividend rate of 36.4%. When the Series A was converted into shares of the Company’s common stock, the carrying value of the converted preferred stock was eliminated and a corresponding increase was recorded to common stock and additional capital. Separately, as a result of the significant issuance discount on the Series A, in the third quarter of 2002, the Company recorded a non-recurring, non-cash preferred stock dividend of $897,000, with an offsetting increase to additional capital, representing the beneficial conversion feature resulting from the Series A being convertible into shares of common stock at an effective price less than the fair market value of the common stock on the date the Series A was issued. The Company recorded Series A preferred stock dividends of $562,000 in 2003 and $1,110,000 in 2002.

 
Issuance and Conversion/ Redemption of Series B Convertible Preferred Stock

      In September 2002, the Company received total proceeds of $4,750,000 in exchange for shares of a newly created Series B Convertible Preferred Stock (“Series B”) and warrants to purchase 421,284 shares of the Company’s common stock. The Series B accrued cumulative dividends at the rate of 6.5% per annum and was initially convertible into 1,242,680 shares of the Company’s common stock at $3.78 per share. The warrants to purchase shares of the Company’s common stock issued to the Series B investors, all of which are outstanding on December 31, 2003, have a current exercise price per share of $4.42 subject to anti-dilution adjustments, became exercisable in March 2003 and expire in September 2006. Series B investors included George W.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Haywood, a private investor and current beneficial owner of approximately 16.0% of the Company’s common stock, who invested $3,450,000.

      In December 2002, $212,000 of Series B and related accrued dividends was voluntarily converted into 56,210 shares of the Company’s common stock and in January 2003, $291,000 of Series B and related accrued dividends was voluntarily converted into 77,040 shares of the Company’s common stock. In May, July and September of 2003, $487,000, $492,000 and $497,000 of Series B and related accrued dividends was redeemed by the Company as scheduled by issuing 128,864, 138,254 and 132,272 shares of the Company’s common stock, respectively. On September 30, 2003, after the Company’s common stock price had closed above $5.67 for ten consecutive trading days, the Company elected to convert the remaining $2,990,000 of Series B and related accrued dividends into 795,223 shares of the Company’s common stock at $3.76 per share.

      Upon their issuance, the fair value of the warrants issued to the Series B investors, aggregating $1,403,000 using the Black-Scholes option pricing model, was recorded as an increase to additional capital with an offsetting reduction in the carrying value of the Series B. The carrying value of the Series B was being accreted, as preferred stock dividends, to their redemption value plus accrued dividends at 6.5% based upon their expected redemption dates using the effective interest rate method, resulting in an effective dividend rate of 36.4%. When the Series B was converted into shares of the Company’s common stock, the carrying value of the converted preferred stock was eliminated and a corresponding increase was recorded to common stock and additional capital. Separately, as a result of the significant issuance discount on the Series B, in the third quarter of 2002, the Company recorded a non-recurring, non-cash preferred stock dividend of $1,727,000, with an offsetting increase to additional capital, representing the beneficial conversion feature resulting from the Series B being convertible into shares of common stock at an effective price less than the fair market value of the common stock on the date the Series B was issued. The Company recorded Series B preferred stock dividends of $843,000 in 2003 and $2,071,000 in 2002.

 
Common Stock Issued to Yahoo! Inc.

      In the third quarter of 2000, the Company entered into an agreement with Yahoo! Inc. (“Yahoo!”) to provide Yahoo! Mail users with the option to send encrypted email messages through the Company’s ZixMessage Center messaging portal. The minimum payments of $6,000,000 were being amortized over two years beginning in December 2000. In April 2002, the Company and Yahoo! entered into an agreement that terminated the Company’s obligation to provide secure messaging services to users of Yahoo! Mail. In connection with the termination of the secure messaging services in the second quarter of 2002, the total remaining commitment owed to Yahoo! was reduced by $850,000, the Company recorded contract termination costs of $600,000, and the Company issued Yahoo! a 6% promissory note in the amount of $2,500,000, which was payable in either cash or common stock at the option of the Company. In July 2002, the $2,500,000 promissory note plus accrued interest was converted into 468,514 shares of the Company’s common stock at a conversion price of $5.41.

 
Common Stock Issued to Tumbleweed Communications Corp.

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

 
Common Stock Issued to Entrust, Inc.

      In November 2000, the Company entered into an Enterprise and CA Services Agreement with Entrust, Inc. (“Entrust”) whereby the Company issued 222,039 shares of the Company’s common stock to Entrust in exchange for licenses to use certain software packages, future technical support and the right to issue a

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

specified number of digital identification certificates to users of the Company’s ZixMail products. These shares were subject to transfer restrictions which lapsed in four equal quarterly installments ending in December 2001. The agreement provided that if the aggregate value of the shares on the dates the restrictions lapsed was less than the transaction value of $3,400,000, the Company would be obligated to fund the deficiency by electing to pay cash or issue additional shares of stock valued at the then-current fair market value of the Company’s common stock. Accordingly, an additional 296,533 shares of the Company’s common stock were issued in December 2001. The digital identification certificates valued at $3,000,000 were written-off to cost of revenues in the fourth quarter of 2001, as these certificates did not enter into sales and marketing plans established by the Company’s new executive management team. Additionally, under a Marketing and Distribution Agreement with Entrust, the Company issued 56,850 shares of the Company’s common stock to Entrust valued at $400,000 upon completion of the integration of the ZixMail service option into the Entrust/ Express® product in August 2001, and the Company and Entrust agreed to share in the related revenues from the integrated product. Although there were no revenues generated from the integrated product, Entrust paid the Company minimum guaranteed annual payments of $500,000 for 2001 and $1,000,000 for 2002, in addition to a final payment of $700,000 in 2003 when the parties cancelled the Marketing and Distribution Agreement (Note 7).

 
Anacom Communications, Inc.

      In October 1999, the Company purchased Anacom Communications, Inc. (“Anacom”), a privately-held provider of real-time transaction processing services to Internet merchants. Consideration consisted of a cash payment of $2,500,000, primarily recorded as goodwill, and common stock, valued at a minimum of $7,500,000, to be delivered in two annual installments beginning October 2000, assuming continued employment by the former owners. The minimum value of the common stock issuable pursuant to the purchase agreement of $7,500,000 was treated as compensation for financial accounting purposes and was being charged to selling, general and administrative expenses over two years with a corresponding increase in stockholders’ equity. Financial accounting rules require the minimum number of common shares issuable be revalued on each subsequent reporting date until performance is complete with a cumulative catch-up adjustment recognized for any changes in their intrinsic value in excess of $7,500,000.

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

 
Private Placement of Equity Securities

      In 2000, the Company, through a private placement, received cash of $44,000,000 in exchange for 916,667 shares of its common stock, ten-year warrants to purchase 916,667 shares of the Company’s common stock at $57.60 per share and four-year warrants to purchase 1,222,223 shares of the Company’s common stock at $12.00 per share. At December 31, 2003, all of the warrants issued were outstanding. Subsequently, in March 2002, the investor group was issued warrants to purchase an additional 916,667 shares of the Company’s common stock at $7.00 per share which expired unexercised in April 2003. The $12.00 and $7.00

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

warrants were reallocated from options with an exercise price of $7.00 per share previously held by David P. Cook, the Company’s founder.

 
Employee and Director Stock Options

      The Company has non-qualified stock options outstanding to employees and directors under various stock option plans. Options granted under these plans are generally not less than the fair market value at the date of grant and, subject to termination of employment, generally expire ten years from the date of grant. Employee options are generally exercisable in installments over two to five years. Option grants to employees and directors frequently contain accelerated vesting provisions upon the occurrence of a change of control, as defined in the applicable option agreements. At December 31, 2003, approximately 789,000 shares of common stock were available for future grants under the Company’s stock option plans.

      During 2000 and 2001, Mr. Cook, founder of the Company, reallocated vested options to acquire 807,127 shares of the Company’s common stock to certain of the Company’s employees and a director. These reallocated options have a five-year term, are fully vested and have exercise prices ranging from $7.00 to $13.75 per share as compared to Mr. Cook’s exercise price of $7.00 per share. Non-cash compensation expense of $16,815,000 has been recognized over the vesting periods ($1,590,000, $9,047,000 and $6,178,000 in 2002, 2001 and 2000, respectively), representing the intrinsic value of the reallocated options based upon the difference between the fair market value of the Company’s common stock on the dates the options were reallocated and the respective option exercise prices.

      In November 2001, Mr. John A. Ryan was appointed chairman, president and chief executive officer of the Company and received a bonus of 152,672 shares of the Company’s common stock valued at $1,000,000. Such stock-based compensation was amortized to selling, general and administrative expenses ratably over two years, the employment period for which the bonus was subject to forfeiture.

      The following is a summary of stock option transactions for 2003, 2002 and 2001:

                   
Weighted Average
Shares Exercise Price


Outstanding at December 31, 2000
    4,896,690     $ 11.41  
 
Granted at market price
    1,156,556     $ 7.38  
 
Granted at prices greater than market
    1,000,000     $ 5.24  
 
Granted at prices less than market
    150,000     $ 7.00  
 
Cancelled
    (518,127 )   $ 9.38  
 
Exercised
    (27,500 )   $ 9.14  
     
         
Outstanding at December 31, 2001
    6,657,619     $ 9.85  
 
Granted at market price
    1,874,580     $ 4.53  
 
Cancelled
    (2,087,182 )   $ 8.95  
     
         
Outstanding at December 31, 2002
    6,445,017     $ 8.59  
 
Granted at market price
    2,436,676     $ 4.54  
 
Cancelled
    (1,105,589 )   $ 10.42  
 
Exercised
    (1,885,387 )   $ 5.83  
     
         
Outstanding at December 31, 2003
    5,890,717     $ 7.46  
     
         

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Summarized information about stock options outstanding at December 31, 2003 is as follows:

                                             
Options Outstanding Options Exercisable


Weighted Average Weighted Weighted
Range of Number Remaining Average Number Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price






  $ 2.50 -  $ 4.99       2,201,770       8.3     $ 4.08       674,632     $ 4.26  
  $ 5.02 -  $11.39       3,190,742       5.9     $ 6.69       2,407,452     $ 6.79  
  $13.00 -  $29.63       350,001       3.7     $ 20.49       345,586     $ 20.58  
  $33.88 -  $44.63       148,204       4.4     $ 43.55       148,204     $ 43.55  
         
                     
         
          5,890,717                       3,575,874          
         
                     
         

      There were 4,017,263 and 3,794,595 exercisable options at December 31, 2002 and 2001, respectively.

 
7. Significant Customers

      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 Company’s Marketing and Distribution Agreement (the “Marketing Agreement”) with Entrust (Note 6). 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, since 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% and 56% of the Company’s revenues in 2003 and 2002, respectively. Separately, in 2003, Cigna Corporation accounted for approximately 10%, or $607,000, of the Company’s total revenues.

 
8. Income Taxes

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

                             
2003 2002 2001



Current:
                       
 
U.S. 
  $     $ (269,000 )   $  
 
Foreign
    167,000              
Deferred:
                       
 
Foreign
    (19,000 )            
     
     
     
 
   
Income tax expense (benefit)
  $ 148,000     $ (269,000 )   $  
     
     
     
 

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ZIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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

                           
2003 2002 2001



Expected tax benefit at U.S. statutory rate
  $ (9,336,000 )   $ (11,753,000 )   $ (19,310,000 )
Unbenefitted U.S. losses, net
    9,571,000       10,986,000       19,313,000  
Nondeductible expense
          670,000        
Other
    (87,000 )     (172,000 )     (3,000 )
     
     
     
 
 
Income tax expense (benefit)
  $ 148,000     $ (269,000 )   $  
     
     
     
 

      The tax expense of $148,000 in 2003 represents taxes associated with 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 carryback period from two years to five years.

      Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Components of the Company’s deferred income taxes as of December 31, 2003 and 2002 are as follows:

                     
2003 2002


Deferred tax assets:
               
 
Nondeductible reserves
  $ 156,000     $ 275,000  
 
U.S. net operating loss carryforwards
    57,543,000       44,859,000  
 
Capital loss carryforwards...
    987,000        
 
Tax credit carryforwards
    2,986,000       2,933,000  
 
Stock-based compensation
    4,612,000       6,006,000  
 
Start-up costs
    589,000       1,135,000  
 
Intangible assets
    758,000       475,000  
 
Investment in equity securities
    21,000       1,785,000  
 
Other assets
    2,189,000       2,718,000  
     
     
 
   
Total deferred tax assets
    69,841,000       60,186,000  
Less valuation allowance
    (69,822,000 )     (60,186,000 )
     
     
 
Net deferred income taxes
  $ 19,000     $  
     
     
 

      The Company has fully reserved its U.S. deferred tax assets in 2003 and 2002 due to the uncertainty of future taxable income. The Company has U.S. net operating loss carryforwards of $169,243,000 which begin to expire in 2019. Tax credit carryforwards of $2,986,000 consist of research tax credits which are available through 2023 and alternative minimum tax credits which do not expire. The net operating loss carryforwards include $13,753,000 resulting from the exercise of non-qualified stock options for which a tax benefit of $4,676,000 will be credited to additional capital when recognized.

 
9. Commitments and Contingencies

      The Company leases its office facilities under noncancelable operating lease agreements. Rental expense for these operating leases was $1,002,000 in 2003, $779,000 in 2002 and $1,038,000 in 2001.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The Company is obligated to make future noncancelable payments under various contracts, including the operating leases and purchase commitments made in the ordinary course of business. The following table summarizes our contractual cash obligations as of December 31, 2003:

                                                 
2004 2005 2006 2007 2008 Thereafter






Operating leases
  $ 1,143,000     $ 1,055,000     $ 867,000     $ 844,000     $ 844,000     $ 1,291,000  
Purchase commitments
    476,000       68,000       67,000                    
     
     
     
     
     
     
 
Total
  $ 1,619,000     $ 1,123,000     $ 934,000     $ 844,000     $ 844,000     $ 1,291,000  
     
     
     
     
     
     
 

      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.

      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.

 
10. Discontinued Operations

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

      The gain on sale of discontinued operations of $89,000, $862,000 and $48,000 in 2003, 2002 and 2001, respectively, primarily represents the reduction of estimated future costs for various indemnification issues associated with the disposal of these businesses. There were no income taxes recorded on these gains.

      Accrued expenses related to discontinued operations of $150,000 and $275,000 at December 31, 2003 and 2002, respectively, consist of estimated future costs for various indemnification issues associated with the disposal of these businesses.

 
11. Related Party Transactions

      In September 2002, the Company completed private placements whereby the Company received an aggregate of $16,000,000 in cash in exchange for convertible equity securities and warrants to purchase the Company’s common stock (Note 6). The Series A Convertible Preferred Stock investors were comprised of Antonio R. Sanchez, Jr., a director and 8.7% beneficial owner of the Company’s common stock, and related entities; John A. Ryan, the Company’s chairman and chief executive officer; and David P. Cook, founder of the Company, who invested $2,000,000, $750,000 and $500,000, respectively. The Series B Convertible Preferred Stock investors included George W. Haywood, a private investor and 16.0% beneficial owner of the Company’s common stock, who invested $3,450,000.

      In December 2000, the Company purchased approximately 9% of the equity ownership of Maptuit Corporation (“Maptuit”) for $3,000,000 in cash and committed to make a follow-on investment. Accordingly, in July 2001, the Company made an additional $2,000,000 cash investment in Maptuit and received a promissory note convertible into Maptuit equity securities. Maptuit, an early stage company, is an Internet application service provider that supplies wireline and wireless Internet location-based services. Mr. Jeffrey P. Papows, a director of the Company from March 2000 to July 2002 and the Company’s chairman of its board of directors from October 2000 to November 2001, served as the president and chief executive officer of

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Maptuit and held a minority equity interest in Maptuit. There was no readily determinable market value for the Company’s investments in Maptuit since Maptuit was privately held. Investments of this nature are subject to significant fluctuations in fair market value due to the volatility of the equity markets and the significant business and investment risks inherent in early stage enterprises. The Company records impairment losses when, in the Company’s judgment, events and circumstances indicate its investment has been impaired. During 2001, Maptuit began seeking third party debt or equity financing to sustain its operations. In the last half of 2001, based upon the uncertainty as to whether Maptuit would be able to raise the necessary funds required to execute its business plan such that the Company would be able to recover its investment, the Company wrote off its $5,000,000 investment in Maptuit and recorded a corresponding investment loss, included in realized and unrealized gains (losses) on investments in the Company’s consolidated statements of operations. In October 2002, in connection with the requirements of a $6,000,000 financing package executed by Maptuit, the Company exchanged its $5,000,000 debt and equity position in Maptuit for $154,000 in cash, a non-interest bearing $900,000 subordinated promissory note due in 2006 and two million shares of common stock of Maptuit. 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. Partial recovery of the Company’s investment in Maptuit has been recorded in the Company’s consolidated statements of operations as realized gains on investments at the time cash was received.

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

      In the fourth quarter of 2000, the Company and Entrust entered into certain technology and marketing agreements (Notes 6 and 7). Mr. Ryan, the Company’s chairman and chief executive officer, was chief executive officer of Entrust when such agreements were executed and held a minority equity interest in Entrust until September 2002.

 
12. Employee Benefit Plans

      The Company has a retirement savings plan structured under Section 401(k) of the Internal Revenue Code covering substantially all of its U.S. employees. Under the plan, contributions are voluntarily made by employees, and the Company may provide contributions based on the employees’ contributions. The Company’s continuing operations includes $161,000, $78,000 and $80,000 in 2003, 2002 and 2001, respectively, for contributions to this plan.

      The Company has an employee stock purchase plan for substantially all employees that meet minimum service requirements. The plan provides for the purchase of up to 300,000 previously issued shares of the Company’s common stock. The employee contributes 85% of the purchase price through payroll deduction with the difference paid by the Company. Since inception of the plan in 1996, a total of 223,971 shares have been purchased including 28,347, 22,729 and 12,856 shares purchased in 2003, 2002 and 2001, respectively.

 
13. International Distribution Agreement

      In June 2001, the Company entered into an agreement with AOS Technologies, Inc. (“AOS”), formerly AlphaOmega Soft Co., Ltd., amended in 2002, whereby AOS became the exclusive distributor in Japan for certain of the Company’s services, including ZixMail and ZixVPM, through 2004. Although the subscription

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

fees generated by AOS were nominal, pursuant to the distribution agreement the Company received minimum payments totaling $300,000. In July 2003, after assessing the additional product and service requirements necessary to compete successfully in Japan and AOS’s failure to pay scheduled installment payments when due, the Company terminated the exclusive distributorship agreement. As a result of the termination of this contract, service revenues for the third quarter of 2003 included $288,000, which represents the final revenues to be recognized under this contract and AOS’s scheduled future minimum payments totaling $900,000 were cancelled.

 
14. Quarterly Results of Operations (Unaudited)

      The following is a summary of the quarterly results of operations for the years ended December 31, 2003 and 2002:

                                 
Quarter Ended

March 31 June 30 September 30 December 31




2003
                               
Revenues
  $ 639,000     $ 1,014,000     $ 2,219,000     $ 1,968,000  
Cost of revenues
    (1,760,000 )     (1,854,000 )     (1,934,000 )     (2,663,000 )
Loss from continuing operations
    (6,831,000 )     (6,055,000 )     (6,506,000 )     (8,275,000 )
Net loss
    (6,831,000 )     (6,055,000 )     (6,506,000 )     (8,186,000 )
Net loss per common share
    (0.36 )     (0.31 )     (0.29 )     (0.29 )
2002
                               
Revenues
  $ 389,000     $ 303,000     $ 434,000     $ 546,000  
Cost of revenues
    (2,895,000 )     (2,513,000 )     (2,024,000 )     (1,567,000 )
Loss from continuing operations
    (9,788,000 )     (8,046,000 )     (9,463,000 )     (7,002,000 )
Net loss
    (9,788,000 )     (7,929,000 )     (8,763,000 )     (6,957,000 )
Net loss per common share
    (0.56 )     (0.45 )     (0.63 )     (0.39 )

      In the third quarter of 2003, the Company acquired substantially all of the operating assets and businesses of Pocket Script and Elron Software (Note 2). The results of operations from these acquisitions are included in the Company’s results of operations from their dates of acquisition. The quarter ended September 30, 2002 includes a non-cash interest expense charge of $1,698,000, representing the beneficial conversion feature resulting from the issuance of notes payable convertible into shares of common stock at an effective price less than the fair market value of the common stock on the date the notes were issued (Note 6).

 
15. Subsequent Events
 
Stock Option and Warrant Exercises

      During the period from January 1, 2004 through March 9, 2004, the Company has received proceeds of approximately $10,318,000, in exchange for 1,262,023 shares of the Company’s common stock as a result of the exercise of stock options and warrants which were outstanding as of December 31, 2003.

 
Business Acquisition — MyDocOnline, Inc. and Related Transactions

      On January 30, 2004, the Company acquired substantially all of the operating assets and business of MyDocOnline, Inc. (“MyDocOnline”), a subsidiary of Aventis Pharmaceuticals, Inc., the North American pharmaceuticals business of Aventis SA and a provider of secure Web-based communications and laboratory information solutions. The consideration for the assets was the issuance of 583,411 shares of the Company’s common stock, with an aggregate value under the asset purchase agreement of $6,900,000, or $11.83 per

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Table of Contents

ZIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

share, representing the average closing price of the Company’s common stock for the 20 trading days ending the second trading day preceding the closing, warrants to purchase 145,853 shares of the Company’s common stock, and the assumption of certain liabilities of MyDocOnline. The exercise price and term of the warrants is $13.01 per share and three years, respectively.

      Also in connection with the acquisition, at closing, Aventis Inc. (“Aventis”) loaned the Company $3,000,000 due March 15, 2007. The loan is evidenced by a secured promissory note. Interest on the note of 4.5% is payable in services provided by the Company to Aventis unless there is an event of default. The principal portion of the note is payable in either cash or shares of the Company’s common stock at the option of the Company and may be prepaid by the Company at any time without penalty. Additionally, at Aventis’ discretion, the principal portion of the note may be paid in the form of additional services provided to Aventis by the Company pursuant to the services agreement described below.

      Additionally, Aventis entered into a three-year service contract with the Company with a minimum commitment of $4,000,000 for the performance by the Company of various services, initially consisting of patient educational services, pursuant to a Master Services Agreement dated January 30, 2004. The services are to be delivered in minimum amounts of $1,000,000, $1,000,000 and $2,000,000 prior to the first, second, and third anniversary dates of the acquisition closing. The $4,000,000 was paid by Aventis upon execution of the Master Services Agreement and will be forfeited by Aventis if services are not used by Aventis in accordance with the terms of the Master Services Agreement. The promissory note 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.

      The Company has filed a registration statement with the Securities and Exchange Commission to register the Company’s shares of common stock delivered at the closing of the acquisition, the Company’s shares of common stock issuable upon the exercise of the warrants, and the Company’s shares of common stock potentially issuable in respect of payment of the promissory note, if any.

      MyDocOnline is an early stage company operating in emerging markets and has historically generated minimal revenues and significant operating losses and utilized substantial amounts of cash. Valuation of the consideration paid for MyDocOnline and the allocation of the resulting purchase price will be determined by management during the first quarter of 2004 based on an independent valuation. For financial reporting purposes, the 583,411 shares of common stock issued by the Company may be required to be valued using the average closing price for a few days before and after the closing of the transaction, which would result in a valuation in excess of the $6,900,000 valuation established by the parties pursuant to the asset purchase agreement. The warrants issued at closing will likely be valued using the Black-Scholes option pricing model. The final purchase price, as calculated, is anticipated to be allocated primarily to property and equipment, various intangible assets and possibly to in-process research and development, which, if present, will be expensed rather than capitalized and amortized over future periods. In connection with the acquisition of substantially all of the assets of MyDocOnline, the Company assumed only certain deferred revenue customer obligations and certain post-acquisition contractual obligations incurred in the normal course of business.

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EXHIBIT 10.2 ZIXIT CORPORATION 1992 STOCK OPTION PLAN (AMENDED AND RESTATED AS OF AUGUST 2000) 1. PURPOSE The purpose of the ZixIt Corporation 1992 Stock Option Plan (hereinafter called the "Plan") is to advance the interests of ZixIt Corporation (hereinafter called the "Company") by strengthening the ability of the Company to attract and retain personnel of high caliber through encouraging a sense of proprietorship by means of stock ownership. Certain options granted under this Plan are intended to qualify as "incentive stock options" pursuant to Section 422 of the Internal Revenue Code of 1986, as amended from time to time (the "Code"), while certain other options granted under this Plan will constitute nonqualified options. 2. DEFINITIONS As used in this Plan, and in any Option Agreement, as hereinafter defined, the following terms shall have the following meanings, unless the context otherwise requires: (a) "Common Stock" shall mean the common stock of the Company, par value $.01 per share, giving effect to the 3 shares for 2 shares stock split on the record date of January 24, 1992 and the effective issuance date of February 13, 1992. (b) "Committee" shall mean a committee of the Board of Directors comprised of at least two directors. Members of the Committee shall be selected by the Board of Directors. To the extent necessary to comply with the requirements of Rule 16b-3, the Committee shall consist of two or more Non-employee Directors. Also, if the requirements of Section 162(m) of the Code are intended to be met, the Committee shall consist of two or more "outside directors" within the meaning of Section 162(m) of the Code. (c) "Date of Grant" shall mean the date on which a stock option is granted pursuant to this Plan. (d) "Effective Date" shall mean the first business day following the date of the 1993 annual meeting of the shareholders of the Company. (e) "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. (f) "Fair Market Value" shall mean the closing sale price (or average of the quoted closing bid and asked prices if there is no closing sale price reported) of the Common Stock on the date specified as reported by NASDAQ/NMS or by the principal national stock exchange on which the Common Stock is then listed. If there is no reported price information for such date, the Fair Market Value will be determined by the reported price information for Common Stock on the day nearest preceding such date. (g) "Non-employee Director" shall have the meaning given such term in Rule 16b-3. (h) "Optionee" shall mean the person to whom an option is granted under this Plan or who has obtained the right to exercise an option in accordance with the provisions of this Plan. -1-

(i) "Plan Adoption Date" means the later of the date on which this Plan is adopted by the Board of Directors of the Company and by the shareholders of the Company in accordance with Rule 16b-3. (j) "Rule 16b-3" shall mean Rule 16b-3 of the rules and regulations under the Exchange Act as it may be amended from time to time and any successor provision to Rule 16b-3 under the Exchange Act. (k) "Subsidiary" shall mean any now existing or hereafter organized or acquired corporation of which more than fifty percent (50%) of the issued and outstanding voting stock is owned or controlled directly or indirectly by the Company or through one or more Subsidiaries of the Company. 3. SHARES SUBJECT TO THIS PLAN Except as otherwise provided by the provisions of Section 9 hereof, the aggregate amount of Common Stock for which options may be granted under this Plan shall not exceed 450,000 shares of Common Stock. Such shares may be authorized and previously unissued shares or previously issued shares that have been reacquired by the Company. Any shares of Common Stock subject to unexercised portions of options granted under this Plan which shall have terminated, been canceled, or expired may again be subject to the granting of options under this Plan. 4. ADMINISTRATION Notwithstanding herein anything to the contrary, to the extent necessary to comply with the requirements of Rule 16b-3, this Plan shall be administered by Committee. Options may be granted under this Section 4 only by majority agreement of the members of the Committee. Stock Option Agreements ("Option Agreements"), in the form as approved by the Committee, and containing such terms and conditions not inconsistent with the provisions of this Plan as shall have been determined by the Committee, may be executed on behalf of the Company by the President or any Vice President of the Company. The Committee shall have complete authority to construe, interpret and administer the provisions of this Plan and the provisions of the option agreements granted hereunder; to prescribe, amend and rescind rules and regulations pertaining to this Plan; and to make all other determinations necessary or deemed advisable in the administration of this Plan. The determinations, interpretations and constructions made by the Committee shall be final and conclusive. 5. ELIGIBILITY Incentive stock options to purchase Common Stock may be granted under Section 4 of this Plan to such employees of the Company or its Subsidiaries (including any director who is also an employee of the Company or one of its Subsidiaries) as shall be determined by the Committee. Nonqualified stock options to purchase Common Stock may be granted under Section 4 of this Plan to such employees or directors of the Company or its Subsidiaries as shall be determined by the Committee. The Committee shall determine which persons are to be granted options under Section 4 of this Plan, the number of options, the number of shares subject to each option, the exercise price or prices of each option, the vesting and exercise period of each option, whether an option may be exercised as to less than all of the Common Stock subject thereto, and such other terms and conditions of each option, if any, as are not inconsistent with the provisions of this Plan. In addition, the Committee may, in its sole discretion, provide for vesting of stock options to accelerate upon a change in control of the Company as defined in an applicable Agreement ("Change in Control") and enable an employee to "put" the excess of the fair market value over the exercise price of the options to the Company in the event of a Change in Control. In connection with the granting of incentive stock options, the aggregate Fair Market Value (determined at the Date of Grant of an incentive stock option) of the shares with respect to which incentive stock options are exercisable for the first time by an Optionee during any calendar year (under all such plans of the Optionee's employer corporation and its -2-

parent and subsidiary corporations as defined in Section 424 of the Code) shall not exceed $100,000 or such other amount as from time to time provided in Section 422(d) of the Code or any successor provision. 6. EXERCISE PRICE The purchase price or prices for Common Stock subject to an option (the "Exercise Price") granted pursuant to Section 4 of this Plan shall be determined by the Committee at the Date of Grant; provided, however, that (a) the Exercise Price for any option shall not be less than 100% of the Fair Market Value of the Common Stock on the Date of Grant, and (b) if the Optionee owns more than 10 percent of the total combined voting power of all classes of stock of the Company or its parent or any of its subsidiaries, as more fully described in Section 422(b)(6) of the Code or any successor provision (such shareholder is referred to herein as a "10-Percent Stockholder"), the Exercise Price for any incentive stock option granted to such Optionee shall not be less than 110% of the Fair Market Value of the Common Stock on the Date of Grant. 7. TERM OF STOCK OPTIONS AND LIMITATIONS ON RIGHT TO EXERCISE No incentive stock option granted pursuant to Section 4 of this Plan shall be exercisable (a) more than five years after the Date of Grant with respect to a 10-Percent Stockholder, and (b) more than ten years after the Date of Grant with respect to all persons other than 10-Percent Stockholders. No nonqualified stock option granted pursuant to Section 4 of this Plan shall be exercisable more than ten years after the Date of Grant. The Company shall not be required to issue any fractional shares upon the exercise of any options granted under this Plan. No Optionee nor his legal representatives, legatees or distributees, as the case may be, will be, or will be deemed to be, a holder of any shares subject to an option unless and until said option has been exercised and the purchase price of the shares in respect of which the option has been exercised has been paid. An option shall not be exercisable except by the Optionee or by a person who has obtained the Optionee's rights under the option by will or under the laws of descent and distribution. 8. TERMINATION OF EMPLOYMENT The Committee shall determine at the Date of Grant what conditions shall apply to the exercise of an option granted under Section 4 in the event an Optionee shall cease to be employed by the Company or a Subsidiary for any reason. In the event of the death of an Optionee while in the employ or while serving as a director of the Company or a Subsidiary, the option theretofore granted to him shall be exercisable by the executor or administrator of the Optionee's estate, or if the Optionee's estate is not in administration, by the person or persons to whom the Optionee's right shall have passed under the Optionee's will or under the laws of descent and distribution, within the year next succeeding the date of death or such other period as may be specified in the Option Agreement, but in no case later than the expiration date of such option, and then only to the extent that the Optionee was entitled to exercise such option at the date of his death. Neither this Plan nor any option granted hereunder is intended to confer upon any Optionee any rights with respect to continuance of employment or other utilization of his services by the Company or by a Subsidiary, nor to interfere in any way with his right or that of his employer to terminate his employment or other services at any time (subject to the terms of any applicable contract). -3-

9. DILUTION OR OTHER ADJUSTMENTS In the event that there is any change in the Common Stock subject to this Plan or subject to options granted hereunder as the result of any stock dividend on, dividend of or stock split or stock combination of, or any like change in, stock of the same class or in the event of any change in the capital structure of the Company, the Board of Directors or the Committee shall make such adjustments with respect to options, or any provisions of this Plan, as it deems appropriate to prevent dilution or enlargement of option rights. 10. EXPIRATION AND TERMINATION OF THIS PLAN Options may be granted at any time under Section 4 of this Plan prior to ten years from this Plan Adoption Date, as long as the total number of shares which may be issued pursuant to options granted under this Plan does not (except as provided in Section 9 above) exceed the limitations of Section 3 above. This Plan may be abandoned, suspended or terminated at any time by the Board of Directors of the Company except with respect to any options then outstanding under this Plan. 11. RESTRICTIONS ON ISSUANCE OF SHARES (a) The Company shall not be obligated to sell or issue any shares upon the exercise of any option granted under this Plan unless: (i) the shares with respect to which such option is being exercised have been registered under applicable federal securities laws or are exempt from such registration; (ii) the prior approval of such sale or issuance has been obtained from any state regulatory body having jurisdiction; and (iii) in the event the Common Stock has been listed on any exchange, the shares with respect to which such option is being exercised have been duly listed on such exchange in accordance with the procedure specified therefor. The Company shall be under no obligation to effect or obtain any listing, registration, qualification, consent or approval with respect to shares issuable on any option. If the shares to be issued upon the exercise of any option granted under this Plan are intended to be issued by the Company in reliance upon the exemptions from the registration requirements of applicable federal securities laws, the Optionee, if so requested by the Company, shall furnish to the Company such evidence and representations, including an opinion of counsel, satisfactory to it, as the Company may reasonably request. The Company shall not be liable for damages due to a delay in the delivery or issuance of any stock certificates for any reason whatsoever, including, but not limited to, a delay caused by listing, registration or qualification of the shares of Common Stock subject to an option upon any securities exchange or under any federal or state law or the effecting or obtaining of any consent or approval of any governmental body with respect to the granting or exercise of the option or the issue or purchase of shares under the option. (b) No option granted pursuant to this Plan shall be transferable by the Optionee other than by will or the laws of descent and distribution or pursuant to a "qualified domestic relations order" as defined in the Code. (c) The Board of Directors or Committee may impose such other restrictions on the ownership -4-

and transfer of shares issued pursuant to this Plan as it deems desirable; any such restrictions shall be set forth in any Option Agreement entered into hereunder. (d) In no event shall any Option granted to any employee who is classified as "non-exempt" under the Fair Labor Standards Act of 1938 be exercisable less than six months after the date of grant, except in the case of death, disability, retirement, a change in control or other circumstances permitted by regulations under the Worker Economic Opportunity Act ("WEOA"). Grants to such non-exempt employees shall not be based on preestablished performance criteria, except as specifically permitted under the WEOA. Non-exempt employees shall be notified of the terms of their Options in accordance with the WEOA, and exercise of such Options must be voluntary. 12. PROCEEDS The proceeds to be received by the Company upon exercise of any option granted under this Plan may be used for any proper purposes. 13. AMENDMENT OF THIS PLAN The Board of Directors may amend this Plan from time to time in such respects as it may deem advisable in its sole discretion or in order that the options granted hereunder shall conform to any change in applicable laws, including tax laws, or in regulations or rulings of administrative agencies or in order that options granted or stock acquired upon exercise of such options may qualify for simplified registration under applicable securities or other laws; provided, however, that, to the extent required by Rule 16b-3 and the Securities and Exchange Commission interpretations and releases thereunder, no amendment may be made without the consent of shareholders which would materially (a) increase the benefits accruing to participants under this Plan, (b) increase the number of securities which may be issued under this Plan, other than in accordance with Section 9 hereof, or (c) modify the requirements as to eligibility for participation in this Plan. 14. PAYMENT UPON EXERCISE Upon the exercise of any option granted under this Plan, the Company may make financing available to the Optionee for the purchase of the Common Stock that may be acquired pursuant to the exercise of such option on such terms as the Committee shall specify. An Optionee may pay the Exercise Price of the shares of Common Stock as to which an option is being exercised by the delivery of cash, a certified cashier's check or, at the Company's option, by the delivery of shares of Common Stock having a Fair Market Value on the date immediately preceding the exercise date equal to the exercise price. If the shares to be purchased are covered by an effective registration statement under the Securities Act of 1933, as amended, any option granted under this Plan may be exercised by a broker-dealer acting on behalf of an Optionee if (a) the broker-dealer has received from the Optionee instructions signed by the Optionee requesting the Company to deliver the shares of Common Stock subject to such option to the broker-dealer on behalf of the Optionee and specifying the account into which such shares should be deposited, (b) adequate provision has been made with respect to the payment of any withholding taxes due upon such exercise, and (c) the broker-dealer and the Optionee have otherwise complied with Section 220.3(e)(4) of Regulation T, 12 CFR Part 220, or any successor provision. 15. LIABILITY OF THE COMPANY Neither the Company, its directors, officers or employees, nor any Subsidiary which is in existence or hereafter comes into existence, shall be liable to any Optionee or other person if it is determined for any -5-

reason by the Internal Revenue Service or any court having jurisdiction that any incentive stock option granted hereunder does not qualify for tax treatment as an incentive stock option under Section 422 of the Code. AMENDED AND RESTATED as of August 1, 2000. ZIXIT CORPORATION By: /s/ Ronald A. Woessner ---------------------- Its: V.P. --------------------- -6-

EXHIBIT 10.7 ZIX CORPORATION 2001 STOCK OPTION PLAN (AMENDED AND RESTATED AS OF MAY 6, 2003) SECTION 1. Purpose. The purpose of the Zix Corporation 2001 Stock Option Plan (hereinafter called the "2001 Plan") is to advance the interests of Zix Corporation (hereinafter called the "Company") by strengthening the ability of the Company to attract, on its behalf and on behalf of its Subsidiaries (as hereinafter defined), and retain personnel of high caliber through encouraging a sense of proprietorship by means of stock ownership. SECTION 2. Definitions. "Board of Directors" shall mean the Board of Directors of the Company. "Code" shall mean the Internal Revenue Code of 1986, as amended from time-to-time. "Committee" shall mean a committee of the Board of Directors comprised of at least two directors or the entire Board of Directors, as the case may be. Members of the Committee shall be selected by the Board of Directors. To the extent necessary to comply with the requirements of Rule 16b-3, the Committee shall consist of two or more Non-employee Directors. Also, if the requirements of Section 162(m) of the Code are intended to be met, the Committee shall consist of two or more "outside directors" within the meaning of Section 162(m) of the Code. "Common Stock" shall mean the Common Stock of the Company, par value $.01 per share. "Date of Grant" shall mean the date on which an Option is granted pursuant to this 2001 Plan. "Designated Beneficiary" shall mean the beneficiary designated by the Optionee, in a manner determined by the Committee, to receive amounts due the Optionee in the event of the Optionee's death. In the absence of an effective designation by the Optionee, Designated Beneficiary shall mean the Optionee's estate. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. "Fair Market Value" shall mean the closing sale price (or average of the quoted closing bid and asked prices if there is no closing sale price reported) of the Common Stock on the date specified as reported by The Nasdaq Stock Market, or by the principal national stock exchange on which the Common Stock is then listed. If there is no reported price information for such date, the Fair Market Value will be determined by the reported price information for Common Stock on the day nearest preceding such date. "Incentive Stock Option" shall mean a stock option granted under Section 6 that is intended to meet the requirements of Section 422 of the Code (or any successor provision). "Non-employee Director" shall have the meaning given such term in Rule 16b-3. "Nonqualified Stock Option" shall mean a stock option granted under Section 6 that is not intended to be an Incentive Stock Option. "Option" shall mean an Incentive Stock Option or a Nonqualified Stock Option. 1

"Optionee" shall mean the person to whom an option is granted under the 2001 Plan or who has obtained the right to exercise an option in accordance with the provisions of the 2001 Plan. "Rule 16b-3" shall mean Rule 16b-3 of the rules and regulations under the Exchange Act as it may be amended from time-to-time and any successor provision to Rule 16b-3 under the Exchange Act. "Subsidiary" shall mean any now existing or hereafter organized or acquired corporation or other entity of which fifty percent (50%) or more of the issued and outstanding voting stock or other economic interest is owned or controlled directly or indirectly by the Company or through one or more Subsidiaries of the Company. SECTION 3. Administration. The 2001 Plan shall be administered by the Committee. The Committee shall have sole and complete authority to adopt, alter and repeal such administrative rules, guidelines and practices governing the operation of the 2001 Plan as it shall from time-to-time deem advisable, and to construe, interpret and administer the terms and provisions of the 2001 Plan and the agreements thereunder. The determinations and interpretations made by the Committee are final and conclusive. SECTION 4. Eligibility. All employees and non-employee consultants and advisors (other than Non-employee Directors) who, in the opinion of the Committee, have the capacity for contributing in a substantial measure to the successful performance of the Company are eligible to receive Options under the 2001 Plan. SECTION 5. Maximum Amount Available for Options. (a) The maximum number of shares of Common Stock in respect of which Options may be made under the 2001 Plan shall be a total of 2,525,000 shares of Common Stock. Of that amount, no participant may be granted Options for more than 1,000,000 shares of Common Stock in the aggregate during the term of the 2001 Plan. Options that expire, lapse or are cancelled or forfeited do not count against theses share limits. Shares of Common Stock may be made available from the authorized but unissued shares of the Company or from shares reacquired by the Company, including shares purchased in the open market. In the event that an Option is terminated unexercised as to any shares of Common Stock covered thereby, such shares shall thereafter be again available for award pursuant to the 2001 Plan. (b) In the event that the Committee shall determine that any stock dividend, recapitalization, reorganization, merger, consolidation, split-up, spin-off, combination, exchange of shares, warrants or rights offering to purchase Common Stock at a price substantially below fair market value, or other similar corporate event affects the Common Stock such that an adjustment is required in order to preserve the benefits or potential benefits intended to be made available under the 2001 Plan, then the Committee shall adjust appropriately any or all of (1) the number and kind of shares which thereafter may be optioned under the 2001 Plan and (2) the grant, exercise or conversion price and/or number of shares with respect to the Options and/or, if deemed appropriate, make provision for cash payment to an Optionee; provided, however, that the number of shares subject to any Option shall always be a whole number. SECTION 6. Stock Options. (a) Subject to the provisions of the 2001 Plan, the Committee shall have sole and complete authority to determine the persons to whom Options shall be granted, the number of shares to be covered by each Option, the option price therefor and the conditions and limitations applicable to the exercise of the Option. 2

(b) The Committee shall have the authority to grant Incentive Stock Options, or to grant Nonqualified Stock Options, or to grant both types of options. In the case of Incentive Stock Options, the terms and conditions of such grants shall be subject to and comply with the Code and relevant regulations. Incentive Stock Options to purchase Common Stock may be granted to such employees of the Company or its Subsidiaries (including any director who is also an employee of the Company or one of its Subsidiaries) as shall be determined by the Committee. Nonqualified Stock Options to purchase Common Stock may be granted to such eligible participants as shall be determined by the Committee. Neither the Company nor any of its Subsidiaries or any of their respective directors, officers or employees, shall be liable to any Optionee or other person if it is determined for any reason by the Internal Revenue Service or any court having jurisdiction that any Incentive Stock Option granted hereunder does not qualify for tax treatment as an Incentive Stock Option under the then-applicable provisions of the Code. (c) The Committee shall, in its discretion, establish the exercise price at the time each Option is granted, which in the case of Nonqualified Stock Options, shall not be less than 100% of the Fair Market Value of the Common Stock on the Date of Grant, or in the case of grants of Incentive Stock Options, shall not be less than 100% of the Fair Market Value of the Common Stock on the Date of Grant or such greater amount as may be prescribed by the Code. (d) Exercise (1) Each Option shall be exercisable at such times and subject to such terms and conditions as the Committee may, in its sole discretion, specify in the applicable grant or thereafter; provided, however, that in no event may any Option granted hereunder be exercisable after the expiration of ten years from the Date of Grant. The Committee may impose such conditions with respect to the exercise of Options, including without limitation, any relating to the application of federal or state securities laws, as it may deem necessary or advisable. (2) No shares shall be delivered pursuant to any exercise of an Option until payment in full of the option price therefore is received by the Company. Such payment may be made in cash, or its equivalent, or, if and to the extent permitted by the Committee or under the terms of the applicable agreement, by exchanging shares of Common Stock owned by the Optionee (which are not the subject of any pledge or other security interest), or by a combination of the foregoing, provided that the combined value of all cash and cash equivalents and the Fair Market Value of any such Common Stock so tendered to the Company, valued as of the date of such tender, is at least equal to such option price. If the shares to be purchased are covered by an effective registration statement under the Securities Act of 1933, as amended, any Option may be exercised by a broker-dealer acting on behalf of an Optionee if (a) the broker-dealer has received from the Optionee instructions signed by the Optionee requesting the Company to deliver the shares of Common Stock subject to such Option to the broker-dealer on behalf of the Optionee and specifying the account into which such shares should be deposited, (b) adequate provision has been made with respect to the payment of any withholding taxes due upon such exercise, and (c) the broker-dealer and the Optionee have otherwise complied with Section 220.3(e)(4) of Regulation T, 12 CFR Part 220, or any successor provision. (3) The Company, in its sole discretion, may lend money to an Optionee, guarantee a loan to an Optionee or otherwise assist an Optionee to obtain the cash necessary to exercise all or any portion of an Option granted under the 2001 Plan. 3

(4) The Company shall not be required to issue any fractional shares upon the exercise of any Options granted under this 2001 Plan. No Optionee nor an Optionee's legal representatives, legatees or distributees, as the case may be, will be, or will be deemed to be, a holder of any shares subject to an Option unless and until said Option has been exercised and the purchase price of the shares in respect of which the Option has been exercised has been paid. Unless otherwise provided in the agreement applicable thereto, an Option shall not be exercisable except by the Optionee or by a person who has obtained the Optionee's rights under the Option by will or under the laws of descent and distribution or pursuant to a "qualified domestic relations order" as defined in the Code. (e) No Incentive Stock Options shall be exercisable (a) more than five years (or such other period of time as from time-to-time provided in the then-applicable provisions of the Code governing Incentive Stock Options) after the Date of Grant with respect to an Optionee who owns ten percent or more of the outstanding Common Stock (within the meaning of the Code), and (b) more than ten years after the Date of Grant with respect to all other Optionees. No Nonqualified Stock Options shall be exercisable more than ten years after the Date of Grant. (f) In no event shall any Option granted to any employee who is classified as "non-exempt" under the Fair Labor Standards Act of 1938 be exercisable less than six months after the Date of Grant, except in the case of death, disability, retirement, a change in control or other circumstances permitted by regulations under the Worker Economic Opportunity Act ("WEOA"). Grants to such non-exempt employees shall not be based on pre-established performance criteria, except as specifically permitted under the WEOA. Non- exempt employees shall be notified of the terms of their Options in accordance with the WEOA, and exercise of such Options must be voluntary. SECTION 7. General Provisions. (a) The Company and its Subsidiaries shall have the right to deduct from all amounts paid to an Optionee in cash (whether under the 2001 Plan or otherwise) any taxes required by law to be withheld in respect of Option exercises under the 2001 Plan. However, if permitted by the Committee or under the terms of the applicable agreement, the Optionee may pay all or any portion of the taxes required to be withheld by the Company or its Subsidiaries or paid by the Optionee with respect to such Common Stock by electing to have the Company or its Subsidiaries withhold shares of Common Stock, or by delivering previously owned shares of Common Stock, having a Fair Market Value equal to the amount required to be withheld or paid. The Optionee must make the foregoing election on or before the date that the amount of tax to be withheld is determined. Any such election is irrevocable and subject to disapproval by the Committee. If the Optionee is subject to the provisions of Section 16(b) of the Exchange Act, then any such election shall be subject to the restrictions imposed by Rule 16b-3. (b) Each Option hereunder shall be evidenced in writing, delivered to the Optionee, and shall specify the terms and conditions thereof and any rules applicable thereto, including, but not limited to, the effect on such Option of the death, retirement, disability or other termination of employment of the Optionee and the effect thereon, if any, of a change in control of the Company. (c) Unless otherwise provided in the agreement applicable thereto, no Option shall be assignable or transferable except by will or under the laws of descent and distribution or pursuant to a "qualified domestic relations order" as defined in the Code, and no right or interest of any Optionee shall be subject to any lien, obligation or liability of the Optionee. (d) No person shall have any claim or right to be granted an Option. Further, the Company and its Subsidiaries expressly reserve the right at any time to terminate the employment of an Optionee free from any liability, or any claim under the 2001 Plan, except as provided in any agreement entered into with 4

respect to an Option. Neither the 2001 Plan nor any Option granted hereunder is intended to confer upon any Optionee any rights with respect to continuance of employment or other utilization of his or her services by the Company or by a Subsidiary, nor to interfere in any way with his or her right or that of his or her employer to terminate his or her employment or other services at any time (subject to the terms of any applicable contract). The conditions to apply to the exercise of an Option in the event an Optionee ceases to be employed by the Company or a Subsidiary for any reason shall be determined by the Committee or specified in the written agreement evidencing the Option. (e) Subject to the provisions of the applicable Option, no Optionee or Designated Beneficiary shall have any rights as a stockholder with respect to any shares of Common Stock to be distributed under the 2001 Plan until he or she has become the holder thereof. (f) The validity, construction, interpretation, administration and effect of the 2001 Plan and of its rules and regulations, and rights relating to the 2001 Plan, shall be determined solely in accordance with the laws of the State of Texas (without giving effect to its conflicts of laws rules) and, to the extent applicable, federal law. (g) The 2001 Plan was originally effective on May 15, 2001. No Options may be granted under the 2001 Plan after May 14, 2011; however, all previous Options issued that have not expired under their original terms or will not then expire at the time the 2001 Plan expires will remain outstanding. (h) Restrictions on Issuance of Shares (1) The Company shall not be obligated to sell or issue any Shares upon the exercise of any Option granted under the 2001 Plan unless: (i) the shares pertaining to such Option have been registered under applicable federal and state securities laws or are exempt from such registration; (ii) the prior approval of such sale or issuance has been obtained from any state regulatory body having jurisdiction; and (iii) in the event the Common Stock has been listed on any exchange, the shares pertaining to such Option have been duly listed on such exchange in accordance with the procedure specified therefor. The Company shall be under no obligation to effect or obtain any listing, registration, qualification, consent or approval with respect to shares pertaining to any Option granted under the 2001 Plan. If the shares to be issued upon the exercise of any Option granted under the 2001 Plan are intended to be issued by the Company in reliance upon the exemptions from the registration requirements of applicable federal and state securities laws, the recipient of the Option, if so requested by the Company, shall furnish to the Company such evidence and representations, including an opinion of counsel, satisfactory to it, as the Company may reasonably request. (2) The Company shall not be liable for damages due to a delay in the delivery or issuance of any stock certificates for any reason whatsoever, including, but not limited to, a delay caused by listing, registration or qualification of the shares of Common Stock pertaining to any Option granted under the 2001 Plan upon any securities exchange or under any federal or state law or the effecting or obtaining of any consent or approval of any governmental body. (i) The Board of Directors or Committee may impose such other restrictions on the ownership and transfer of shares issued pursuant to the 2001 Plan as it deems desirable; any such restrictions shall be set forth in the applicable agreement. (j) The Board of Directors may amend, abandon, suspend or terminate the 2001 Plan or any portion thereof at any time in such respects as it may deem advisable in its sole discretion, provided that no amendment shall be made without stockholder approval (including an increase in the maximum number of shares of Common Stock in respect of which Options may be made under the 2001 Plan) if such 5

stockholder approval is necessary to comply with any tax or regulatory requirement or exchange listing rules, including for these purposes any approval requirement that is a prerequisite for exemptive relief under Section 16(b) of the Exchange Act. (k) To preserve an Optionee's rights under an Option in the event of a change in control of the Company or an Optionee's separation from employment, the Committee in its discretion may, at the time an Option is made or any time thereafter, take one or more of the following actions: (i) provide for the acceleration of any time period relating to the exercise of the Option, (ii) provide for the purchase of the Option, upon the Optionee's request, for an amount of cash or other property that could have been received upon the exercise or realization of the Option had the Option been currently exercisable or payable, (iii) adjust the terms of the Option in a manner determined by the Committee to reflect the change in control or to prevent the imposition of an excise tax under section 280G(b) of the Code, (iv) cause the Option to be assumed, or new rights substituted therefor, by another entity, or (v) make such other provision as the Committee may consider equitable and in the best interests of the Company. AMENDED AND RESTATED as of May 6, 2003. ZIX CORPORATION By: /s/ Ronald A. Woessner ---------------------- Title: S.V.P. 6

EXHIBIT 10.9 ZIX CORPORATION 2003 NEW EMPLOYEE STOCK OPTION PLAN SECTION 1. PURPOSE The purpose of the Zix Corporation 2003 New Employee Stock Option Plan (hereinafter called the "Plan") is to advance the interests of Zix Corporation (hereinafter called the "Company") by strengthening the ability of the Company to attract, on its behalf and on behalf of its Subsidiaries (as hereinafter defined), personnel of high caliber through encouraging a sense of proprietorship by means of stock ownership. The Plan, as written and as administered by the Committee, is intended to comply with NASD Rule 4350(i)(1)(A)(iv), which provides that shareholder approval is not required for issuer equity issuances to certain employees. SECTION 2. DEFINITIONS "Board of Directors" shall mean the Board of Directors of the Company. "Code" shall mean the Internal Revenue Code of 1986, as amended from time-to-time. "Committee" shall mean a committee of the Board of Directors comprised of a majority of Independent Directors or a majority of the Company's Independent Directors, as the case may be. "Common Stock" shall mean the Common Stock of the Company, par value $.01 per share. "Date of Grant" shall mean the date on which an Option is granted pursuant to this Plan. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. "Fair Market Value" shall mean the closing sale price (or average of the quoted closing bid and asked prices if there is no closing sale price reported) of the Common Stock on the date specified as reported by the Nasdaq National Market, or by the principal national stock exchange on which the Common Stock is then listed. If there is no reported price information for such date, the Fair Market Value will be determined by the reported price information for Common Stock on the day nearest preceding such date. "Independent Director" shall have the meaning given such term in NASDAQ Rule 4200(a)(14). "Nonqualified Stock Option" shall mean a stock option granted under Section 6 that is not intended to be an incentive stock option. "Option" shall mean an option granted under the Plan. "Optionee" shall mean the person to whom an option is granted under the Plan or who has obtained the right to exercise an option in accordance with the provisions of the Plan. "Subsidiary" shall mean any now existing or hereafter organized or acquired corporation or other entity of which fifty percent (50%) or more of the issued and outstanding voting stock or other economic interest is owned or controlled directly or indirectly by the Company or through one or more Subsidiaries of the Company. 1

SECTION 3. ADMINISTRATION The Plan shall be administered by the Committee. The Committee shall have sole and complete authority to adopt, alter and repeal such administrative rules, guidelines and practices governing the operation of the Plan as it shall from time-to-time deem advisable, and to construe, interpret and administer the terms and provisions of the Plan and the agreements thereunder. The determinations and interpretations made by the Committee are final and conclusive. SECTION 4. ELIGIBILITY The following persons are eligible to receive options under the Plan: employees (other than officers or directors) of the Company or a Subsidiary that were not previously an employee or director of the Company or a Subsidiary, or if previously such, have experienced a bona fide period of non-employment with the Company and its Subsidiaries, in each case, if the option grant is in connection with such person entering into employment with the Company or a Subsidiary and is offered to them as an inducement for them to enter into such employment. SECTION 5. MAXIMUM AMOUNT AVAILABLE FOR OPTIONS (a) The maximum number of shares of Common Stock in respect of which Options may be made under the Plan shall be a total of 500,000 shares of Common Stock. Options that expire, lapse or are cancelled or forfeited nonetheless continue to count against the 500,000 share limit. Shares of Common Stock may be made available from the authorized but unissued shares of the Company or from shares reacquired by the Company, including shares purchased in the open market. In the event that an Option is terminated unexercised as to any shares of Common Stock covered thereby, such shares shall thereafter be again available for award pursuant to the Plan. (b) In the event that the Committee shall determine that any stock dividend, recapitalization, reorganization, merger, consolidation, split-up, spin-off, combination, exchange of shares, warrants or rights offering to purchase Common Stock at a price substantially below fair market value, or other similar corporate event affects the Common Stock such that an adjustment is required in order to preserve the benefits or potential benefits intended to be made available under the Plan, then the Committee shall adjust appropriately any or all of (1) the number and kind of shares which thereafter may be optioned under the Plan and (2) the grant, exercise or conversion price and/or number of shares with respect to the Options and/or, if deemed appropriate, make provision for cash payment to an Optionee; provided, however, that the number of shares subject to any Option shall always be a whole number. SECTION 6. STOCK OPTIONS (a) Subject to the provisions of the Plan, the Committee shall have sole and complete authority to determine the persons to whom Options shall be granted, the number of shares to be covered by each Option, the option price therefor and the conditions and limitations applicable to the exercise of the Option. (b) The Committee shall have the authority to grant Nonqualified Stock Options only. Nonqualified Stock Options to purchase Common Stock may be granted to such eligible participants as shall be determined by the Committee. (c) The Committee shall, in its discretion, establish the exercise price at the time each Option is granted, which in the case of Nonqualified Stock Options, shall not be less than 100% of the Fair Market Value of the Common Stock on the Date of Grant. The exercise price of any outstanding Options may not be repriced without the approval of the Company's stockholders (obtained in accordance with applicable law), given in each specified instance. 2

(d) Exercise (1) Each Option shall be exercisable at such times and subject to such terms and conditions as the Committee may, in its sole discretion, specify in the applicable grant or thereafter; provided, however, that in no event may any Option granted hereunder be exercisable after the expiration of ten years from the Date of Grant, unless otherwise permitted by the Committee. The Committee may impose such conditions with respect to the exercise of Options, including without limitation, any relating to the application of federal or state securities laws, as it may deem necessary or advisable. (2) No shares shall be delivered pursuant to any exercise of an Option until payment in full of the option price therefore is received by the Company. Such payment may be made in cash, or its equivalent, or, if and to the extent permitted by the Committee or under the terms of the applicable agreement, by exchanging shares of Common Stock owned by the Optionee (which are not the subject of any pledge or other security interest), or by a combination of the foregoing, provided that the combined value of all cash and cash equivalents and the Fair Market Value of any such Common Stock so tendered to the Company, valued as of the date of such tender, is at least equal to such option price. If the shares to be purchased are covered by an effective registration statement under the Securities Act of 1933, as amended, any Option may be exercised by a broker-dealer acting on behalf of an Optionee if (a) the broker-dealer has received from the Optionee instructions signed by the Optionee requesting the Company to deliver the shares of Common Stock subject to such Option to the broker-dealer on behalf of the Optionee and specifying the account into which such shares should be deposited, (b) adequate provision has been made with respect to the payment of any withholding taxes due upon such exercise, and (c) the broker-dealer and the Optionee have otherwise complied with Section 220.3(e)(4) of Regulation T, 12 CFR Part 220, or any successor provision. (3) The Company, in its sole discretion, may lend money to an Optionee, guarantee a loan to an Optionee or otherwise assist an Optionee to obtain the cash necessary to exercise all or any portion of an Option granted under the Plan. (4) The Company shall not be required to issue any fractional shares upon the exercise of any Options granted under this Plan. No Optionee nor an Optionee's legal representatives, legatees or distributees, as the case may be, will be, or will be deemed to be, a holder of any shares subject to an Option unless and until said Option has been exercised and the purchase price of the shares in respect of which the Option has been exercised has been paid. Unless otherwise provided in the agreement applicable thereto, an Option shall not be exercisable except by the Optionee or by a person who has obtained the Optionee's rights under the Option by will or under the laws of descent and distribution or pursuant to a "qualified domestic relations order" as defined in the Code. (e) In no event shall any Option granted to any employee who is classified as "non-exempt" under the Fair Labor Standards Act of 1938 be exercisable less than six months after the Date of Grant, except in the case of death, disability, retirement, a change in control or other circumstances permitted by regulations under the Worker Economic Opportunity Act ("WEOA"). Grants to such non-exempt employees shall not be based on pre-established performance criteria, except as specifically permitted under the WEOA. Non-exempt employees shall be notified of the terms of their Options in accordance with the WEOA, and exercise of such Options must be voluntary. 3

SECTION 7. GENERAL PROVISIONS (a) The Company and its Subsidiaries shall have the right to deduct from all amounts paid to an Optionee in cash (whether under the Plan or otherwise) any taxes required by law to be withheld in respect of Option exercises under the Plan. However, if permitted by the Committee or under the terms of the applicable agreement, the Optionee may pay all or any portion of the taxes required to be withheld by the Company or its Subsidiaries or paid by the Optionee with respect to such Common Stock by electing to have the Company or its Subsidiaries withhold shares of Common Stock, or by delivering previously owned shares of Common Stock, having a Fair Market Value equal to the amount required to be withheld or paid. The Optionee must make the foregoing election on or before the date that the amount of tax to be withheld is determined. Any such election is irrevocable and subject to disapproval by the Committee. (b) Each Option hereunder shall be evidenced in writing, delivered to the Optionee, and shall specify the terms and conditions thereof and any rules applicable thereto, including, but not limited to, the effect on such Option of the death, retirement, disability or other termination of employment of the Optionee and the effect thereon, if any, of a change in control of the Company. (c) Unless otherwise provided in the agreement applicable thereto, no Option shall be assignable or transferable except by will or under the laws of descent and distribution or pursuant to a "qualified domestic relations order" as defined in the Code, and no right or interest of any Optionee shall be subject to any lien, obligation or liability of the Optionee. (d) No person shall have any claim or right to be granted an Option. Further, the Company and its Subsidiaries expressly reserve the right at any time to terminate the employment of an Optionee free from any liability, or any claim under the Plan. Neither the Plan nor any Option granted hereunder is intended to confer upon any Optionee any rights with respect to continuance of employment or other utilization of his or her services by the Company or by a Subsidiary, nor to interfere in any way with his or her right or that of his or her employer to terminate his or her employment or other services at any time. The conditions to apply to the exercise of an Option in the event an Optionee ceases to be employed by the Company or a Subsidiary for any reason shall be determined by the Committee or specified in the written agreement evidencing the Option. (e) Subject to the provisions of the applicable Option, no Optionee or permitted assignee shall have any rights as a stockholder with respect to any shares of Common Stock to be distributed under the Plan until he or she has become the holder thereof. (f) The validity, construction, interpretation, administration and effect of the Plan and of its rules and regulations, and rights relating to the Plan, shall be determined solely in accordance with the laws of the State of Texas (without giving effect to its conflicts of laws rules) and, to the extent applicable, federal law. (g) Restrictions on Issuance of Shares (1) The Company shall not be obligated to sell or issue any Shares upon the exercise of any Option granted under the Plan unless: (i) the shares pertaining to such Option have been registered under applicable federal and state securities laws or are exempt from such registration; (ii) the prior approval of such sale or issuance has been obtained from any state regulatory body having jurisdiction; and (iii) in the event the Common Stock has been listed on any exchange, the shares pertaining to such Option have been duly listed on such exchange in accordance with the procedure specified therefor. The Company shall be under no obligation to effect or obtain any listing, registration, qualification, consent or approval with respect to shares pertaining to any 4

Option granted under the Plan. If the shares to be issued upon the exercise of any Option granted under the Plan are intended to be issued by the Company in reliance upon the exemptions from the registration requirements of applicable federal and state securities laws, the recipient of the Option, if so requested by the Company, shall furnish to the Company such evidence and representations, including an opinion of counsel, satisfactory to it, as the Company may reasonably request. (2) The Company shall not be liable for damages due to a delay in the delivery or issuance of any stock certificates for any reason whatsoever, including, but not limited to, a delay caused by listing, registration or qualification of the shares of Common Stock pertaining to any Option granted under the Plan upon any securities exchange or under any federal or state law or the effecting or obtaining of any consent or approval of any governmental body. (h) The Board of Directors or Committee may impose such other restrictions on the ownership and transfer of shares issued pursuant to the Plan as it deems desirable; any such restrictions shall be set forth in the applicable agreement. (i) The Board of Directors may amend, abandon, suspend or terminate the Plan or any portion thereof at any time in such respects as it may deem advisable in its sole discretion, provided that no amendment shall be made without stockholder approval if such stockholder approval is necessary to comply with any tax or regulatory requirement or listing rules. The Plan has not been submitted for stockholder approval. (j) To preserve an Optionee's rights under an Option in the event of a change in control of the Company or an Optionee's separation from employment, the Committee in its discretion may, at the time an Option is made or any time thereafter, take one or more of the following actions: (i) provide for the acceleration of any time period relating to the exercise of the Option, (ii) provide for the purchase of the Option, upon the Optionee's request, for an amount of cash or other property that could have been received upon the exercise or realization of the Option had the Option been currently exercisable or payable, (iii) adjust the terms of the Option in a manner determined by the Committee to reflect the change in control or to prevent the imposition of an excise tax under section 280G(b) of the Code, (iv) cause the Option to be assumed, or new rights substituted therefor, by another entity, or (v) make such other provision as the Committee may consider equitable and in the best interests of the Company. IN WITNESS WHEREOF, the Company has caused the Plan to be executed on its behalf as of the 1st day of October 2003. ZIX CORPORATION By: Ronald A. Woessner -------------------------------------- Title: SVP Date: 1/15/04 5

Exhibit 10.10 CONNECTICUT GENERAL LIFE INSURANCE COMPANY DEFINED CONTRIBUTION PLAN BASIC PLAN DOCUMENT NUMBER 03 AS AMENDED TO INCORPORATE THE PROVISIONS OF THE URUGUAY ROUND AGREEMENTS ACT (GATT), THE SMALL BUSINESS JOB PROTECTION ACT OF 1996 (SBJPA), THE INTERNAL REVENUE CODE SECTION 414(u) PROVISIONS OF THE UNIFORMED SERVICES EMPLOYMENT AND REEMPLOYMENT RIGHTS ACT OF 1994 (USERRA), THE TAXPAYER RELIEF ACT OF 1997 (TRA '97); AND THE INTERNAL REVENUE SERVICE RESTRUCTURING AND REFORM ACT OF 1998 (RRA).

TABLE OF CONTENTS SECTION CONTENTS PAGE ARTICLE I - DEFINITIONS 1.1 Accrued Benefit ................................................................................ 1 1.2 Additional Matching Contributions .............................................................. 1 1.3 Additional Nonelective Contributions ........................................................... 1 1.4 Adoption Agreement ............................................................................. 1 1.5 Alternate Payee ................................................................................ 1 1.6 Annuity ........................................................................................ 1 1.7 Annuity Contract ............................................................................... 1 1.8 Annuity Starting Date .......................................................................... 1 1.9 Beneficiary .................................................................................... 2 1.10 Board of Directors ............................................................................. 2 1.11 CODA ........................................................................................... 2 1.12 Code ........................................................................................... 2 1.13 Compensation ................................................................................... 2 1.14 Considered Net Profits ......................................................................... 6 1.15 Contribution Period ............................................................................ 6 1.16 Davis-Beacon Act ............................................................................... 6 1.17 Disability ..................................................................................... 7 1.18 Disability Retirement Date ..................................................................... 7 1.19 Early Retirement Date .......................................................................... 7 1.20 Earned Income .................................................................................. 7 1.21 Effective Date ................................................................................. 8 1.22 Elective Deferral Contributions ................................................................ 8 1.23 Employee ....................................................................................... 8 1.24 Employee Contributions ......................................................................... 8 1.25 Employer ....................................................................................... 9 1.26 Entry Date ..................................................................................... 9 1.27 ERISA .......................................................................................... 9 1.28 Fiduciary ...................................................................................... 9 1.29 Forfeiture ..................................................................................... 10 1.30 Highly Compensated Employee .................................................................... 10 1.31 Insurance Company .............................................................................. 12 1.32 Late Retirement Date ........................................................................... 12 1.33 Leased Employee ................................................................................ 12 1.34 Life Annuity ................................................................................... 13 1.35 Life Insurance Policy .......................................................................... 13 1.36 Matching Contributions ......................................................................... 13 1.37 Money Purchase Pension Contributions ........................................................... 13 1.38 Named Fiduciary ................................................................................ 13 1.39 Nonelective Contributions ...................................................................... 13 1.40 Non-Trusteed ................................................................................... 14 1.41 Normal Retirement Age .......................................................................... 14 1.42 Normal Retirement Date ......................................................................... 14 1.43 Owner-Employee ................................................................................. 14 1.44 Participant .................................................................................... 14 1.45 Participant's Account .......................................................................... 14 1.46 Participant's Employer Stock Account ........................................................... 15 1.47 Partner ........................................................................................ 16 1.48 Partnership .................................................................................... 16 1.49 Person ......................................................................................... 16 1.50 Plan ........................................................................................... 16 -i-

1.51 Plan Administrator ............................................................................. 17 1.52 Plan Year ...................................................................................... 17 1.53 Prevailing Wage Law ............................................................................ 17 1.54 Prior Employer Contributions ................................................................... 17 1.55 Prior Required Employee Contributions .......................................................... 17 1.56 Prior Voluntary Employee Contributions ......................................................... 17 1.57 QDRO ........................................................................................... 17 1.58 Qualified Matching Contributions ............................................................... 17 1.59 Qualified Nonelective Contributions ............................................................ 18 1.60 QVEC Contributions ............................................................................. 18 1.61 Required Employee Contributions ................................................................ 18 1.62 Rollover Contribution .......................................................................... 18 1.63 Salary Deferral Agreement ...................................................................... 18 1.64 Self-Employed Individual ....................................................................... 18 1.65 Serious Financial Hardship ..................................................................... 18 1.66 Shareholder-Employee ........................................................................... 18 1.67 Social Security Integration Level .............................................................. 18 1.68 Social Security Taxable Wage Base .............................................................. 18 1.69 Sponsoring Organization ........................................................................ 18 1.70 Spouse ......................................................................................... 18 1.71 Straight Life Annuity .......................................................................... 18 1.72 Termination of Employment ...................................................................... 18 1.73 True-Up Contributions .......................................................................... 18 1.74 Trust .......................................................................................... 19 1.75 Trustee ........................................................................................ 19 1.76 Vested Interest ................................................................................ 19 1.77 Vesting Percentage ............................................................................. 19 1.78 Voluntary Employee Contributions ............................................................... 20 ARTICLE II - GENERAL PROVISIONS 2A. SERVICE 2A.1 Service ........................................................................................ 21 2A.2 Absence from Employment ........................................................................ 21 2A.3 Hour of Service ................................................................................ 21 2A.4 1-Year Break-in-Service ........................................................................ 22 2A.5 Year(s) of Service ............................................................................. 22 2A.6 Determining Vesting Percentage ................................................................. 24 2A.7 Excluded Years of Service for Vesting .......................................................... 24 2A.8 Change in Plan Years ........................................................................... 25 2A.9 Elapsed Time ................................................................................... 25 2A.10 Excluded Periods of Service for Vesting ........................................................ 26 2B. ELIGIBILITY, ENROLLMENT AND PARTICIPATION 2B.1 Eligibility .................................................................................... 27 2B.2 Enrollment ..................................................................................... 27 2B.3 Reemployed Participant ......................................................................... 28 2B.4 Eligible Class ................................................................................. 28 2B.5 Waiver of Participation ........................................................................ 28 2C. CONTRIBUTIONS AND ALLOCATIONS 2C.1 Profit Sharing/Thrift Plan with 401(k) Feature ................................................. 29 2C.2 Money Purchase Pension Plan .................................................................... 41 2C.3 Rollover Contributions ......................................................................... 44 2C.4 Participant Initiated Transfers................................................................. 44 -ii-

2C.5 Contributions Subject to Davis-Bacon Act ....................................................... 46 2C.6 QVEC Contributions ............................................................................. 46 ARTICLE III - DISTRIBUTIONS 3A. TIMING AND FORM OF BENEFITS 3A.1 Payment of Benefits ............................................................................ 47 3A.2 Commencement of Benefits ....................................................................... 50 3A.3 From Life Insurance Policies ................................................................... 51 3A.4 Nontransferable ................................................................................ 51 3A.5 Alternate Payee Special Distribution ........................................................... 51 3B. MINIMUM DISTRIBUTION REQUIREMENTS 3B.1 Definitions .................................................................................... 52 3B.2 Distribution Requirements ...................................................................... 54 3B.3 Death Distribution Provisions .................................................................. 55 3B.4 Transitional Rule .............................................................................. 56 3C. JOINT AND SURVIVOR ANNUITY REQUIREMENTS 3C.1 Applicability .................................................................................. 58 3C.2 Definitions .................................................................................... 58 3C.3 Qualified Joint and Survivor Annuity ........................................................... 59 3C.4 Qualified Preretirement Survivor Annuity ....................................................... 59 3C.5 Notice Requirements ............................................................................ 60 3C.6 Safe Harbor Rules .............................................................................. 61 3C.7 Transitional Rules ............................................................................. 62 3D. TERMINATION OF EMPLOYMENT 3D.1 Distribution ................................................................................... 64 3D.2 Repayment of Prior Distribution ................................................................ 65 3D.3 Life Insurance Policy .......................................................................... 66 3D.4 No Further Rights or Interest .................................................................. 66 3D.5 Forfeiture ..................................................................................... 66 3D.6 Lost Participant ............................................................................... 67 3D.7 Deferral of Distribution ....................................................................... 67 -iii-

3E. WITHDRAWALS 3E.1 Withdrawal - Employee Contributions ............................................................ 67 3E.2 Withdrawal - Elective Deferral Contributions ................................................... 68 3E.3 Withdrawal - Qualified Matching Contributions................................................... 68 3E.4 Withdrawal - Qualified Nonelective Contributions................................................ 68 3E.5 Withdrawal - Safe Harbor 401(k) Elective Deferral Contributions and ADP Test Safe Harbor Contributions............................................ 69 3E.6 Withdrawal - Employer Contributions ............................................................ 69 3E.7 Withdrawal for Serious Financial Hardship of Contributions Other than Elective Deferral Contributions........................................ 70 3E.8 Withdrawal for Serious Financial Hardship of Elective Deferral Contributions ................... 70 3E.9 Withdrawal - QVEC Contributions and Rollover Contributions ..................................... 72 3E.10 Notification ................................................................................... 72 3E.11 Vesting Continuation ........................................................................... 72 3E.12 Withdrawal - Participant's Employer Stock Account .............................................. 72 3F. DIRECT ROLLOVERS 3F.1 Definitions .................................................................................... 72 3F.2 Direct Rollovers ............................................................................... 73 ARTICLE IV - LEGAL LIMITATIONS ON CONTRIBUTIONS 4A. NONDISCRIMINATION TESTS 4A.1 Definitions .................................................................................... 74 4A.2 Actual Deferral Percentage Test ................................................................ 75 4A.3 Special Rules - ADP Test ....................................................................... 76 4A.4 Actual Contribution Percentage Test ............................................................ 77 4A.5 Special Rules - ADP/ACP Tests .................................................................. 78 4B. LIMITATIONS ON ALLOCATIONS 4B.1 Definitions .................................................................................... 80 4B.2 Basic Limitation ............................................................................... 85 4B.3 Estimated Maximum Permissible Amount ........................................................... 85 4B.4 Actual Maximum Permissible Amount .............................................................. 85 4B.5 Participants Covered by Another Prototype Defined Contribution Plan ............................ 86 4B.6 Participants Covered by Non-Prototype Defined Contribution Plan ................................ 87 4B.7 Participants Covered by Defined Benefit Plan ................................................... 87 4C. TREATMENT OF EXCESSES 4C.1 Definitions .................................................................................... 87 4C.2 Excess Elective Deferral Contributions ......................................................... 88 4C.3 Excess Annual Additions ........................................................................ 89 4C.4 Excess Contributions ........................................................................... 90 4C.5 Excess Aggregate Contributions ................................................................. 91 -iv-

ARTICLE V - PARTICIPANT PROVISIONS 5A. ANNUITY CONTRACT AND PARTICIPANT'S ACCOUNT 5A.1 Participant's Account .......................................................................... 93 5A.2 Investment Transfers ........................................................................... 93 5A.3 Participant's Account Valuation ................................................................ 93 5B. LIFE INSURANCE POLICIES 5B.1 Optional Purchase of Life Insurance ............................................................ 94 5B.2 Premiums on Life Insurance Policies ............................................................ 94 5B.3 Limitations on Premiums ........................................................................ 94 5B.4 Disposal ....................................................................................... 95 5B.5 Rights under Policies .......................................................................... 95 5B.6 Loans .......................................................................................... 95 5B.7 Conditions of Coverage ......................................................................... 95 5B.8 Policy Not Yet in Force ........................................................................ 95 5B.9 Value of Policy ................................................................................ 95 5B.10 Dividends ...................................................................................... 96 5B.11 Distribution ................................................................................... 96 5B.12 Application .................................................................................... 96 5C. LOANS 5C.1 Loans to Participants .......................................................................... 96 5C.2 Loan Procedures ................................................................................ 97 5C.3 USERRA Loan Suspension.......................................................................... 98 5D. PARTICIPANTS' RIGHTS 5D.1 General Rights of Participants and Beneficiaries ............................................... 98 5D.2 Filing a Claim for Benefits .................................................................... 98 5D.3 Denial of Claim ................................................................................ 98 5D.4 Remedies Available to Participants ............................................................. 98 5D.5 Limitation of Rights ........................................................................... 99 5D.6 100% Vested Contributions ...................................................................... 99 5D.7 Reinstatement of Benefit ....................................................................... 99 5D.8 Non-Alienation ................................................................................. 99 ARTICLE VI - OVERSEER PROVISIONS 6A. FIDUCIARY DUTIES AND RESPONSIBILITIES 6A.1 General Fiduciary Standard of Conduct .......................................................... 110 6A.2 Service in Multiple Capacities ................................................................. 110 6A.3 Limitations on Fiduciary Liability ............................................................. 110 6A.4 Investment Manager ............................................................................. 110 6B. THE PLAN ADMINISTRATOR 6B.1 Designation and Acceptance ..................................................................... 110 6B.2 Duties and Responsibility ...................................................................... 110 6B.3 Special Duties ................................................................................. 111 6B.4 Expenses and Compensation ...................................................................... 111 6B.5 Information from Employer ...................................................................... 111 6B.6 Administrative Committee; Multiple Signatures .................................................. 111 6B.7 Resignation and Removal; Appointment of Successor .............................................. 112 -v-

6B.8 Investment Manager ............................................................................. 112 6B.9 Delegation of Duties ........................................................................... 112 6C. TRUST AGREEMENT 6C.1 Creation and Acceptance of Trust ............................................................... 113 6C.2 Trustee Capacity; Co-Trustees .................................................................. 113 6C.3 Resignation and Removal; Appointment of Successor Trustee ...................................... 113 6C.4 Taxes, Expenses and Compensation of Trustee .................................................... 113 6C.5 Trustee Entitled to Consultation ............................................................... 114 6C.6 Rights, Powers and Duties of Trustee ........................................................... 114 6C.7 Evidence of Trustee Action ..................................................................... 116 6C.8 Investment Policy .............................................................................. 116 6C.9 Period of the Trust ............................................................................ 117 6D. THE INSURANCE COMPANY 6D.1 Duties and Responsibilities .................................................................... 117 6D.2 Relation to Employer, Plan Administrator and Participants ...................................... 117 6D.3 Relation to Trustee ............................................................................ 117 6E. ADOPTING EMPLOYER 6E.1 Election to Become Adopting Employer ........................................................... 117 6E.2 Definition ..................................................................................... 118 6E.3 Effective Date of Plan ......................................................................... 118 6E.4 Forfeitures .................................................................................... 118 6E.5 Contributions .................................................................................. 118 6E.6 Expenses ....................................................................................... 118 6E.7 Substitution of Plans .......................................................................... 118 6E.8 Termination of Plans ........................................................................... 118 6E.9 Amendment ...................................................................................... 118 6E.10 Plan Administrator's Authority ................................................................. 119 ARTICLE VII - SPECIAL CIRCUMSTANCES WHICH MAY AFFECT THE PLAN 7A. TOP-HEAVY PROVISIONS 7A.1 Definitions .................................................................................... 120 7A.2 Minimum Allocation ............................................................................. 123 7A.3 Minimum Vesting Schedule ....................................................................... 124 7B. AMENDMENT, TERMINATION OR MERGER OF THE PLAN 7B.1 Amendment of Elections under Adoption Agreement by Employer .................................... 125 7B.2 Amendment of Plan, Trust, and Form of Adoption Agreement ....................................... 126 7B.3 Conditions of Amendment ........................................................................ 127 7B.4 Termination of the Plan ........................................................................ 127 7B.5 Full Vesting ................................................................................... 127 7B.6 Application of Forfeitures ..................................................................... 127 7B.7 Merger with Other Plan ......................................................................... 127 7B.8 Transfer from Other Plans ...................................................................... 128 7B.9 Transfer to Other Plans ........................................................................ 128 7B.10 Approval by the Internal Revenue Service ....................................................... 128 7B.11 Subsequent Unfavorable Determination ........................................................... 129 7C. SUBSTITUTION OF PLANS -vi-

7C.1 Substitution of Plans .......................................................................... 129 7C.2 Transfer of Assets ............................................................................. 129 7C.3 Substitution for Pre-Existing Master or Prototype Plan ......................................... 130 7C.4 Partial Substitution or Partial Transfer of the Plan or Assets ................................. 130 ARTICLE VIII - MISCELLANEOUS 8.1 Nonreversion ................................................................................... 131 8.2 Gender and Number .............................................................................. 131 8.3 Reference to the Internal Revenue Code and ERISA ............................................... 131 8.4 Governing Law .................................................................................. 131 8.5 Compliance with the Internal Revenue Code and ERISA ............................................ 131 8.6 Contribution Recapture ......................................................................... 131 -vii-

CONNECTICUT GENERAL LIFE INSURANCE COMPANY DEFINED CONTRIBUTION PLAN BASIC PLAN DOCUMENT NUMBER 03 The Plan set forth herein may be adopted by an Employer and accepted by the Plan Administrator and, if applicable, the Trustee by executing an Adoption Agreement, which together shall constitute the Employer's Plan, for the exclusive benefit of its eligible Employees and their Beneficiaries, as fully as if set forth in said Adoption Agreement; provided, however, no Employer may adopt this Plan except with the consent of Connecticut General Life Insurance Company. An Employer's adoption of this Plan shall not supersede any previously adopted amendments made to reflect the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001(EGTRRA) or Code section 401(a)(9) final regulations. ARTICLE I - DEFINITIONS 1.1 ACCRUED BENEFIT. The term Accrued Benefit means the value of the Participant's Account on any applicable date. 1.2 ADDITIONAL MATCHING CONTRIBUTIONS. The term Additional Matching Contributions means additional discretionary Matching Contributions made to the Plan by the Employer, as authorized by its Board of Directors by resolution. Additional Matching Contributions shall be treated as Matching Contributions for nondiscrimination testing and allocation purposes. 1.3 ADDITIONAL NONELECTIVE CONTRIBUTIONS. The term Additional Nonelective Contributions means additional discretionary Nonelective Contributions made to the Plan by the Employer, as authorized by its Board of Directors by resolution. 1.4 ADOPTION AGREEMENT. The term Adoption Agreement means the prescribed agreement by which the Employer adopts this Plan, and which sets forth the elective provisions of this Plan as specified by the Employer. 1.5 ALTERNATE PAYEE. The term Alternate Payee means a person, other than the Participant, identified under a QDRO to be a recipient of part or all of the Participant's benefit under the Plan. 1.6 ANNUITY. The term Annuity means a series of payments made over a specified period of time. 1.7 ANNUITY CONTRACT. The term Annuity Contract means the group annuity contract form issued by the Insurance Company to fund the benefits provided under this Plan, as such contract may be amended from time to time in accordance with the terms thereof. The Employer will specify and communicate to its Employees the types of investments available under this Plan and Annuity Contract. 1.8 ANNUITY STARTING DATE. The term Annuity Starting Date means the first day of the first period for which an amount is paid as an Annuity or any other form. Article I - Definitions February 6, 2002 -1-

1.9 BENEFICIARY. The term Beneficiary means the beneficiary or beneficiaries entitled to any benefits under a Participant's Account hereunder upon the death of a Participant, Beneficiary or Alternate Payee pursuant to a QDRO. If any Life Insurance Policy is purchased on the life of a Participant hereunder, the Beneficiary under such Policy shall be designated separately therein. However, any such Beneficiary designation shall be subject to the terms of Section 3C. A Participant's Beneficiary shall be his Spouse, if any, unless the Participant designates a person or persons other than his Spouse as Beneficiary with his Spouse's written consent. A Participant may designate a Beneficiary on the form approved by the Plan Administrator. If any distribution is made to a Beneficiary in the form of an Annuity, and if such Annuity provides for a death benefit, then such Beneficiary shall also have a right to designate a beneficiary and to change that beneficiary from time to time. As an alternative to receiving the benefit in the form of an Annuity, the Beneficiary may elect to receive a single cash payment or any other form of payment provided by the Employer's election in the Adoption Agreement. If no Beneficiary has been designated pursuant to the provisions of this Section, or if no Beneficiary survives the Participant and he has no surviving Spouse, then the Beneficiary under the Plan shall be the deceased Participant's surviving children in equal shares or, if there are no surviving children, the Participant's estate. If a Beneficiary dies after becoming entitled to receive a distribution under the Plan but before distribution is made to him in full, and if no other Beneficiary has been designated to receive the balance of the distribution in that event, the estate of the deceased Beneficiary shall be the Beneficiary for the balance of the distribution. If the Employer so elects in the Adoption Agreement, an Alternate Payee and/or Beneficiary shall be allowed to direct the investment of his segregated portion of the Participant's Account, pursuant to Section 5A. An individual who is designated as an Alternate Payee in a QDRO relating to a Participant's benefits under this Plan shall be treated as a Beneficiary hereunder, to the extent provided by such order. 1.10 BOARD OF DIRECTORS. The term Board of Directors means the Employer's board of directors or other comparable governing body. 1.11 CODA. The term CODA means cash or deferred arrangement as described in Code section 401(k) and the regulations thereunder. 1.12 CODE. The term Code means the Internal Revenue Code of 1986, as amended from time to time. 1.13 COMPENSATION. The term Compensation means Compensation as defined below. For any Self-Employed Individual covered under the Plan, Compensation shall mean Earned Income. Compensation shall include only that Compensation which is actually paid to the Participant during the applicable Determination Period. Except as provided elsewhere in this Plan, the "Determination Article I - Definitions February 6, 2002 -2-

Period" shall be the period elected by the Employer in the Adoption Agreement. If the Employer makes no election, the Determination Period shall be the Plan Year. An Employer may elect in the Adoption Agreement to use one of the following definitions of Compensation for purposes of allocating all contributions: (a) WAGES, TIPS, AND OTHER COMPENSATION BOX ON FORM W-2. (Information required to be reported under Code sections 6041, 6051 and 6052). Wages within the meaning of Code section 3401(a) and all other payments of compensation to an Employee by the Employer (in the course of the Employer's trade or business) for which the Employer is required to furnish the Employee a written statement under Code sections 6041(d), 6051(a)(3), and 6052. Compensation must be determined without regard to any rules under Code section 3401(a) that limit the remuneration included in wages based on the nature or location of the employment or the services performed (such as the exception for agricultural labor in Code section 3401(a)(2)). (b) SECTION 3401(a) WAGES. Wages as defined in Code section 3401(a) for the purposes of income tax withholding at the source but determined without regard to any rules that limit the remuneration included in wages based on the nature or location of the employment or the services performed (such as the exception for agricultural labor in Code section 3401(a)(2)). (c) 415 SAFE-HARBOR COMPENSATION. Wages, salaries, and fees for professional services and other amounts received (without regard to whether or not an amount is paid in cash) for personal services actually rendered in the course of employment with the Employer maintaining the Plan to the extent that the amounts are includable in gross income (including, but not limited to, commissions paid salesmen, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, bonuses, fringe benefits, and reimbursements or other expense allowances under a nonaccountable plan as described in Code section 1.62-2(c)), and excluding the following: (1) Employer contributions to a plan of deferred compensation which are not includable in the Employee's gross income for the taxable year in which contributed, or Employer contributions under a simplified employee pension plan to the extent such contributions are deductible by the Employee, or any distributions from a plan of deferred compensation; (2) Amounts realized from the exercise of a non-qualified stock option, or when restricted stock (or property) held by the Employee either becomes freely transferable or is no longer subject to a substantial risk of forfeiture; Article I - Definitions February 6, 2002 -3-

(3) Amounts realized from the sale, exchange or other disposition of stock acquired under a qualified stock option; and (4) Other amounts which received special tax benefits, or contributions made by the Employer (whether or not under a salary reduction agreement) towards the purchase of an annuity contract described in Code section 403(b) (whether or not the contributions are actually excludable from the gross income of the Employee). (d) MODIFIED WAGES, TIPS, AND OTHER COMPENSATION BOX ON FORM W-2. Compensation as defined in subsection (a) above, but reduced by all of the following items (even if includable in gross income): reimbursements or other expense allowances, fringe benefits (cash or noncash), moving expenses, deferred compensation, and welfare benefits. This definition may not be used by standardized plans or plans using a contribution or allocation formula that is integrated with Social Security. (e) MODIFIED SECTION 3401(a) WAGES. Compensation as defined in subsection (b) above, but reduced by all of the following items (even if includable in gross income): reimbursements or other expense allowances, fringe benefits (cash or noncash), moving expenses, deferred compensation, and welfare benefits. This definition may not be used by standardized plans or plans using a contribution or allocation formula that is integrated with Social Security. (f) MODIFIED 415 SAFE-HARBOR COMPENSATION. Compensation as defined in subsection (c) above, but reduced by all of the following items (even if includable in gross income): reimbursements or other expense allowances, fringe benefits (cash or noncash), moving expenses, deferred compensation, and welfare benefits. This definition may not be used by standardized plans or plans using a contribution or allocation formula that is integrated with Social Security. (g) REGULAR OR BASE SALARY OR WAGES. Regular or base salary or wages (excluding overtime and bonuses) received during the applicable period by the Employee from the Employer. This definition may not be used by standardized plans or plans using a contribution or allocation formula that is integrated with Social Security. (h) REGULAR OR BASE SALARY WAGES PLUS OVERTIME AND/OR BONUSES. Regular or base salary or wages, plus either or both overtime and/or bonuses, as elected by the Employer in the Adoption Agreement, received during the applicable period by the Employee from the Employer. This definition may not be used by standardized plans or plans using a contribution or allocation formula that is integrated with Social Security. (i) A REASONABLE ALTERNATIVE DEFINITION OF COMPENSATION, as that term is used in Code section 414(s)(3) and the regulations thereunder, provided that the definition does not favor Article I - Definitions February 6, 2002 -4-

Highly Compensated Employees and satisfies the nondiscrimination requirements under Code section 414(s). This definition may not be used by standardized plans or plans using a contribution or allocation formula that is integrated with Social Security. For years beginning before January 1, 1998, if elected by the Employer in the Adoption Agreement, Compensation shall include any amount which is contributed by the Employer pursuant to a salary reduction agreement and which is not includable in the gross income of the Employee under Code sections 125, 402(e)(3), 402(h)(1)(B) or 403(b). For years beginning on or after January 1, 1998, if elected by the Employer in the Adoption Agreement, Compensation shall exclude any amount which is contributed by the Employer pursuant to a salary reduction agreement and which is not includible in gross income of the Employee under Code sections 125, 402(e)(3), 402 (h)(1)(B) or 403(b). Effective for years beginning on or after January 1, 2001 (or such earlier date specified in section IV.C of the Adoption Agreement which cannot be earlier than January 1, 1998), Code section 132(f)(4) deferrals shall be treated in the same manner as section 125 deferrals. For years beginning on or after January 1, 1994, the annual Compensation of each Participant taken into account for determining all benefits provided under the Plan for any Plan Year shall not exceed $150,000, as adjusted for increases in the cost-of-living in accordance with Code section 401(a)(17)(B). The cost-of-living adjustment in effect for a calendar year applies to any Determination Period beginning in such calendar year. If a Determination Period consists of fewer than 12 calendar months, then the annual compensation limit is an amount equal to the annual compensation limit for the calendar year in which the compensation period begins, multiplied by the ratio obtained by dividing the number of full months in the period by 12. For Determination Periods beginning before January 1, 1997, in determining the Compensation of a Participant for purposes of this limit, the rules of Code section 414(q)(6), as in effect prior to January 1, 1997, shall apply, except in applying such rules, the term "family" shall include only the spouse of the Participant and any lineal descendants of the Participant who have not attained age 19 before the close of the year. If, as a result of the application of such rules, the adjusted annual Compensation limit is exceeded, then (except for purposes of determining the portion of Compensation up to the integration level if this Plan uses a contribution or allocation formula that is integrated with Social Security), the limit shall be prorated among the affected individuals in proportion to each such individual's Compensation as determined under this Section prior to the application of this limit. The provisions of this paragraph shall not apply for Determination Periods beginning on or after January 1, 1997. Article I - Definitions February 6, 2002 -5-

In determining allocations in Plan Years beginning on or after January 1, 1994, the annual compensation limit in effect for Determination Periods beginning before that date is $150,000. 1.14 CONSIDERED NET PROFITS. The term Considered Net Profits means the entire amount of the accumulated or current operating profits (excluding capital gains from the sale or involuntary conversion of capital or business assets) of the Employer after all expenses and charges other than (1) the Employer contribution to this and any other qualified plan, and (2) federal, state or local taxes based upon or measured by income, as determined by the Employer, either on an estimated basis or a final basis, in accordance with the generally accepted accounting principles used by the Employer. When, for any Plan Year, the amount of Considered Net Profits has been determined by the Employer, and the Employer contribution made on the basis of such determination, such determination and contribution shall be final and conclusive and shall not be subject to change because of any adjustments in income or expense which may be required by the Internal Revenue Service or otherwise. Such determination and contribution shall not be open to question by any Participant either before or after the Employer contribution has been made. In the case of an Employer that is a non-profit entity, the term Considered Net Profits means the entire amount of the accumulated or current operating surplus (excluding capital gains from the sale or involuntary conversion of capital or business assets) of the Employer after all expenses and charges other than (1) the contribution made by the Employer to the Plan, and (2) federal, state or local taxes based upon or measured by income, in accordance with the generally accepted accounting principles used by the Employer. 1.15 CONTRIBUTION PERIOD. The term Contribution Period means that regular period, specified by the Employer in its Adoption Agreement, for which the Employer shall make Employer contributions, if any, and that regular period specified by the Employer in its Adoption Agreement, for which Participants may make Employee Contributions, if any, and Elective Deferral Contributions, if any. The first Contribution Period may be an irregular period, not longer than one month, commencing not prior to the Effective Date. However, the first Contribution Period for Elective Deferral Contributions may not commence before the later of the Plan's Effective Date or adoption date. 1.16 DAVIS-BACON ACT The term Davis-Bacon Act means the Davis-Bacon Act (40 U.S.C. section 276(a) et seq., as amended from time to time), which guarantees minimum wages to laborers and mechanics employed on Federal government contracts for the construction, alteration, or repair of public buildings or works. The minimums are the amounts found by the Secretary of Labor to be prevailing for similar workers in the area in which the work is to be done. The term "wages" as used in the Davis-Bacon Act includes, in addition to the basic hourly rate of pay, contributions irrevocably made to trustees for pension benefits for laborers and mechanics employed on Federal government contracts and the Article I - Definitions February 6, 2002 -6-

cost of other fringe benefits. However, overtime pay is to be computed only on the basis of the basic hourly rate of pay. Davis-Bacon contributions are only allowed in non-standardized plans. 1.17 DISABILITY. The term Disability means a Participant's incapacity to engage in any substantial gainful activity because of a medically determinable physical or mental impairment which can be expected to result in death, or which has lasted or can be expected to last for a continuous period of not less than 12 months. The permanence and degree of such impairment shall be supported by medical evidence. All Participants in similar circumstances shall be treated alike. If elected by the Employer in the Adoption Agreement, nonforfeitable contributions will be made to the Plan on behalf of all disabled Participants. 1.18 DISABILITY RETIREMENT DATE. The term Disability Retirement Date means the first day of the month after the Plan Administrator has determined that a Participant's incapacity is a Disability. A Participant who retires from the Service of the Employer as of his Disability Retirement Date shall have a Vesting Percentage of 100% and shall be entitled to receive a distribution of the entire value of his Participant's Account and any Life Insurance Policies, or the values thereof, as of his Disability Retirement Date, subject to the provisions of Section 3A and Section 3C. 1.19 EARLY RETIREMENT DATE. If the Employer has specified in its Adoption Agreement that Early Retirement is permitted, then the term Early Retirement Date means the first day of the month coinciding with or next following the date a Participant is separated from Service with the Employer for any reason other than death or Disability, provided that on such date the Participant has attained the conditions specified by the Employer in its Adoption Agreement and has not attained his Normal Retirement Age. A Participant who retires from the Service of the Employer on or after his Early Retirement Date shall have a Vesting Percentage of 100% and shall be entitled to receive a distribution of the entire value of his Participant's Account and any Life Insurance Policies, or the values thereof, as of his Early Retirement Date, subject to the provisions of Section 3A and Section 3C. If a Participant separates from Service before satisfying the age requirement for Early Retirement, but has satisfied the Service requirement, the Participant shall be 100% vested as of his Termination of Employment date, but he will not be eligible for a distribution of the entire value of his Participant's Account until satisfying such age requirement. 1.20 EARNED INCOME. The term Earned Income means the net earnings from self-employment in the trade or business with respect to which the Plan is established, and for which the personal services of the individual are a material income-producing factor. Net earnings will be determined without regard to items not included in gross income and the deductions allocable to such items. Net earnings are reduced by contributions made by the Article I - Definitions February 6, 2002 -7-

Employer to a qualified plan to the extent deductible under Code section 404. Net earnings shall be determined with regard to the deductions allowed to the taxpayer by Code section 164(f) for taxable years beginning after December 31, 1989. 1.21 EFFECTIVE DATE. The term Effective Date means the date specified by the Employer in its Adoption Agreement as the Effective Date of the Plan. 1.22 ELECTIVE DEFERRAL CONTRIBUTIONS. The term Elective Deferral Contributions means contributions made by the Employer to the Plan at the election of the Participant (or, if elected by the Employer in the Adoption Agreement, through a deemed election by an Employee), in lieu of cash compensation, and shall include contributions made pursuant to a Salary Deferral Agreement or other deferral mechanism. With respect to any taxable year, a Participant's elective deferral is the sum of all Employer contributions made on behalf of such Participant pursuant to an election to defer under any CODA, any simplified employee pension cash or deferred arrangement as described in section 402(h)(1)(B), any SIMPLE IRA plan described in section 408(p), any eligible deferred compensation plan as described in section 457, any plan described in section 501(c)(18), and any Employer contributions made on the behalf of a Participant for the purchase of an annuity contract under section 403(b) pursuant to a salary reduction agreement. Elective Deferral Contributions shall not include those contributions properly distributed as Excess Annual Additions, as defined in Section 4C.1(b). 1.23 EMPLOYEE. The term Employee means any employee of the Employer maintaining the Plan or any other employer required to be aggregated with such Employer under Code sections 414(b), (c), (m), or (o). The term Employee also includes any Leased Employee deemed to be an Employee of the Employer in accordance with Code sections 414(n) or (o). If elected by the Employer in the Adoption Agreement, an individual shall not be treated as an Employee unless he or she is reported on the payroll, income tax withholding, wage tax liability, or worker compensation coverage records, or any such similar record, of the Employer as a common law employee, or is otherwise explicitly covered as a Leased Employee. Under this provision, individuals not treated as common law employees by the Employer on the type of records previously described shall be excluded from participation in the Plan even if a court or administrative agency later determines that such individuals are common law employees. This provision applies only to non-standardized plans. 1.24 EMPLOYEE CONTRIBUTIONS. The term Employee Contributions means contributions to this Plan or any other plan, that are designated Article I - Definitions February 6, 2002 -8-

or treated at the time of contribution as after-tax contributions made by the Employee and are allocated to a separate account to which attributable earnings and losses are allocated. Such term includes Required Employee Contributions, Voluntary Employee Contributions, Prior Required Employee Contributions, and Prior Voluntary Employee Contributions. 1.25 EMPLOYER. The term Employer means the employer that adopts this Plan. In the case of a group of Employers that constitutes a controlled group of corporations (as defined in Code section 414(b)) or that constitutes trades or businesses (whether or not incorporated) that are under common control (as defined in section 414(c)) or that constitutes an affiliated service group (as defined in section 414(m)), Service with all such employers shall be considered Service with the Employer for purposes of eligibility and vesting. The term Employer shall also mean any Adopting Employer as defined in Section 6E.2. A state or local government or political subdivision thereof, or any agency or instrumentality thereof, may not elect a 401(k) option (CODA) in the Adoption Agreement, unless the sponsoring entity is a rural cooperative as defined in Code section 401(k)(7)(E)(iv). 1.26 ENTRY DATE. The term Entry Date means either the Effective Date or each applicable date thereafter as specified by the Employer in its Adoption Agreement, when an Employee who has fulfilled the eligibility requirements commences participation in the Plan. If an Employee is not in the active Service of the Employer as of his initial Entry Date, his subsequent Entry Date shall be the date he returns to the active Service of the Employer, provided he still meets the eligibility requirements. If an Employee does not enroll as a Participant as of his initial Entry Date, his subsequent Entry Date shall be the applicable Entry Date as specified by the Employer in the Adoption Agreement when the Employee actually enrolls as a Participant. 1.27 ERISA. The term ERISA means the Employee Retirement Income Security Act of 1974 (PL93-406) as it may be amended from time to time, and any regulations issued pursuant thereto as such Act and such regulations affect this Plan and Trust. 1.28 FIDUCIARY. The term Fiduciary means any or all of the following, as applicable: (a) Any Person who exercises any discretionary authority or control respecting the management of the Plan or its assets; (b) Any Person who renders investment advice for a fee or other compensation, direct or indirect, respecting any monies or other property of the Plan or has authority or responsibility to do so; (c) Any Person who has discretionary authority or responsibility in the administration of the Plan; Article I - Definitions February 6, 2002 -9-

(d) Any Person who has been designated by a Named Fiduciary pursuant to authority granted by the Plan, who acts to carry out a fiduciary responsibility, subject to any exceptions granted directly or indirectly by ERISA. 1.29 FORFEITURE. The term Forfeiture means the amount, if any, by which the value of a Participant's Account exceeds his Vested Interest upon the occurrence of an immediate Break-in-Service, a 1-Year Break-in-Service or 5 consecutive 1-Year Breaks-in-Service, as elected by the Employer in its Adoption Agreement pursuant to Section 3D.5, following such Participant's Termination of Employment. 1.30 HIGHLY COMPENSATED EMPLOYEE. The term Highly Compensated Employee includes both Highly Compensated Active Employees and Highly Compensated Former Employees. (a) STANDARD METHOD: Effective for Plan Years beginning after December 31, 1996, a "Highly Compensated Active Employee" includes any Employee who performs service for the Employer during the Plan Year and who: (1) During either the current Plan Year (the "Determination Period") or the immediately preceding 12-month period (the "Look-Back Year"), owns (or is considered to own within the meaning of section 318 of the Code, as modified by section 416(I)(1)(B)(iii) of the Code) more than 5% of the outstanding stock of the Employer or stock possessing more than 5% of the total voting power of all stock of the Employer, or, if the Employer is other than a corporation, owns more than 5% of the capital or profits interest in the Employer. The determination of 5% ownership shall be made separately for each member of a controlled group of corporations (as defined in Code section 414(b)), or a group of businesses under common control (as defined in Code section 414(c)), or for an affiliated service group (as defined in Code section 414(m)); or (2) During the Look-Back Year, (A) Received Compensation in excess of $80,000 (as indexed); and (B) If elected by the Employer in the Adoption Agreement, was in the top 20% of Employees of the Employer ranked by Compensation (the "Top-Paid Group"). A "Highly Compensated Former Employee" includes any Employee who separated from Service (or was deemed to have separated) prior to the Determination Year, performs no service for the Employer during the Determination Year, and was a highly compensated active employee for either the separation year or any Determination Year ending on or after the Employee's 55th birthday. Article I - Definitions February 6, 2002 -10-

The determination of who is a Highly Compensated Employee, including the determinations of the number and identity of the Employees in the top-paid group, will be made in accordance with Code section 414(q) and the regulations thereunder. If elected by the Employer in the Adoption Agreement, a Plan with a non-calendar year Plan Year may elect to treat the calendar year beginning with or within the Look-Back Year as the Look-Back Year for purposes of determining whether an Employee is a Highly Compensated Employee on account of the Employee's Compensation for a Look-Back Year. For purposes of this definition, Compensation shall mean compensation as defined in Code section 415(c)(3). For Plan Years beginning before January 1, 1998, for purposes of this definition, Compensation also includes elective or salary reduction contributions to a cafeteria plan, CODA or tax-sheltered annuity even though excluded from the definition under Code section 415(c)(3) for those years. Effective for Plan Years beginning on or after the date specified by the Employer in section XIII.C of the Adoption Agreement (Limitations on Allocations), Compensation shall include elective amounts that are not includible in the gross income of the Employee by reason of Code section 132(f)(4). (b) HIGHLY COMPENSATED EMPLOYEE DETERMINATION ON SNAPSHOT BASIS: If elected by the Employer in the Adoption Agreement, the Employer may determine who is a Highly Compensated Employee and substantiate that the Plan complies with the nondiscrimination requirements on the basis of the Employer's work force on a single day during the Plan Year, provided that day is reasonably representative of the Employer's work force and the Plan's coverage throughout the Plan Year. The day elected by the Employer and indicated on the Adoption Agreement shall be the "Snapshot Day." To apply the snapshot basis methodology: (1) The Employer determines who is a Highly Compensated Employee on the basis of the data as of the Snapshot Day, except as provided in (3) below. (2) If the determination of who is a Highly Compensated Employee is made earlier than the last day of the Plan Year, the Employee's Compensation that is used to determine an Employee's status must be projected for the Plan Year under a reasonable method established by the Employer.(3) If there are Employees not employed on the Snapshot Day who are taken into account in testing, they must be determined to be either Highly Compensated Employees or non-Highly Compensated Employees. In addition to those Employees who are determined to be Highly Compensated Employees on the Plan's Snapshot Day, the Employer Article I - Definitions February 6, 2002 -11-

must treat as a Highly Compensated Employee any eligible Employee for the Plan Year who: (a) Terminated employment prior to the Snapshot Day and was a 5% Owner in the prior or current Plan Year; (b) Terminated employment prior to the Snapshot Day and had Compensation for the Look-Back Year greater than or equal to the Compensation in the Look-Back Year of any Employee who is treated as a Highly Compensated Employee on the Snapshot Day (except for Employees who are Highly Compensated Employees solely because they are 5-percent owners; or (c) Becomes employed during the Plan Year but after the Snapshot Day and is a 5-percent owner. 1.31 INSURANCE COMPANY. The term Insurance Company means Connecticut General Life Insurance Company, a legal reserve life insurance company of Hartford, Connecticut. If any company other than Connecticut General Life Insurance Company has issued any Life Insurance Policy held by the Trustee under the Plan, then with respect to such Policy only and matters pertaining directly thereto, the term Insurance Company shall be deemed to refer to such other issuing company. 1.32 LATE RETIREMENT DATE. The term Late Retirement Date means the first day of the month coinciding with or next following the date a Participant is separated from Service with the Employer after his Normal Retirement Age, for any reason other than death. 1.33 LEASED EMPLOYEE. The term Leased Employee means any person (other than an Employee of the recipient Employer) who, pursuant to an agreement between the recipient Employer and any other person ("leasing organization"), has performed services for the recipient Employer (or for the recipient Employer and related persons determined in accordance with Code section 414(n)(6)) on a substantially full-time basis for a period of at least one year, and such services are performed under the primary direction or control of the recipient Employer. Contributions or benefits provided a Leased Employee by the leasing organization which are attributable to services performed for the recipient Employer shall be treated as provided by the recipient Employer. A Leased Employee shall not be considered an Employee of the recipient Employer if such employee is covered by a money purchase pension plan of the leasing organization providing: (a) a nonintegrated employer contribution rate of at least 10 percent of compensation, as defined in Code section 415(c)(3), but including amounts contributed pursuant to a salary reduction agreement which are excludable from the employee's gross income under section 125, section 402(e)(3), section 402(h)(1)(B), section 403(b) or section 132(f)(4) of the Code, (b) immediate participation, and (c) full and immediate vesting; and Leased Employees do not constitute more than 20 percent of the recipient's non-highly compensated work force. Article I - Definitions February 6, 2002 -12-

1.34 LIFE ANNUITY The term Life Annuity means an Annuity payable over the life or life expectancy of one or more individuals. 1.35 LIFE INSURANCE POLICY. The term Life Insurance Policy (or Policy) means a policy of individual life insurance purchased from the Insurance Company on the life of any Participant. 1.36 MATCHING CONTRIBUTIONS. The term Matching Contributions means contributions made by the Employer to the Plan for a Participant on account of either Elective Deferral Contributions or Required Employee Contributions. In addition, any Forfeiture reallocated as a Matching Contribution shall be considered a Matching Contribution for purposes of this Plan. If elected by the Employer in the Adoption Agreement, Matching Contributions shall be made out of Considered Net Profits in an amount specified by the Employer in its Adoption Agreement for each $1.00 contributed as either an Elective Deferral Contribution or a Required Employee Contribution, as further specified by the Employer in its Adoption Agreement. The term Matching Contributions shall include Additional Matching Contributions, True-Up Contributions, ADP Test Safe Harbor Contributions, and ACP Test Safe Harbor Matching Contributions. Should there be insufficient Considered Net Profits of the Employer for such Employer contribution, the amount of such Matching Contributions may be diminished to the amount that can be made from the Employer's Considered Net Profits. The Employer may designate at the time of contribution that all or a portion of such Matching Contributions be treated as Qualified Matching Contributions. If elected by the Employer in the Adoption Agreement, Partners shall not be entitled to receive Matching Contributions. If Partners are entitled to receive Matching Contributions, for Plan Years prior to 1998, such Contributions shall be considered Elective Deferral Contributions for all purposes under this Plan. 1.37 MONEY PURCHASE PENSION CONTRIBUTIONS. The term Money Purchase Pension Contributions means contributions made to the Plan by the Employer in accordance with a definite formula as specified in the Adoption Agreement. 1.38 NAMED FIDUCIARY. The term Named Fiduciary means the Administrator and any other Fiduciary designated by the Employer, and any successor thereto. 1.39 NONELECTIVE CONTRIBUTIONS. The term Nonelective Contributions means contributions made to the Plan by the Employer in accordance with a definite formula as specified in the Adoption Agreement. The Employer may designate at the time of contribution that the Nonelective Contribution shall be treated as a Qualified Nonelective Contribution. The term Nonelective Contributions shall include nonelective contributions that are ADP Test Safe Harbor Contributions. Article I - Definitions February 6, 2002 -13-

1.40 NON-TRUSTEED. The term Non-Trusteed means that the Employer has specified in the Adoption Agreement that there will not be a Trust as a part of the Plan. Contributions under a Non-Trusteed plan will be made directly to the Insurance Company. If the Employer specifies in the Adoption Agreement that the Plan is Non-Trusteed, then the terms and provisions of this Plan relating to the Trust shall be of no force or effect. 1.41 NORMAL RETIREMENT AGE. The term Normal Retirement Age means the age selected in the Adoption Agreement. If the Employer enforces a mandatory retirement age, the Normal Retirement Age is the lesser of that mandatory age or the age specified in the Adoption Agreement. Notwithstanding the vesting schedule elected by the Employer in the Adoption Agreement, an Employee's right to his or her account balance shall be nonforfeitable upon the attainment of Normal Retirement Age. 1.42 NORMAL RETIREMENT DATE. The term Normal Retirement Date means the first day of the month coinciding with or next following the date a Participant attains his Normal Retirement Age. If a Participant retires from the Service of the Employer on his Normal Retirement Date, he shall receive a distribution of the entire value of his Participant's Account, as of his Normal Retirement Date, subject to the provisions of Section 3A and Section 3C. 1.43 OWNER-EMPLOYEE. The term Owner-Employee means an individual who is a sole proprietor, or who is a Partner owning more than 10 percent of either the capital or profits interest of the Partnership. 1.44 PARTICIPANT. The term Participant means any person who has a Participant's Account in the Plan and/or Trust. Notwithstanding the foregoing, for purposes of making or receiving contributions under the plan, the term Participant means a current or former Employee who is or was employed during the Contribution Period or Plan Year, as applicable, and who meets or met the eligibility and allocation requirements for participation, as further described in the Adoption Agreement. If elected by the Employer in the Adoption Agreement, and only for purposes of the investment of contributions as described in Section 5A, the term Participant shall include former Participants, Beneficiaries, and Alternate Payees. Former Participants shall include those Participants who upon Termination of Employment elected to defer distribution in accordance with Section 3A of the Plan. 1.45 PARTICIPANT'S ACCOUNT. The term Participant's Account means the sum of the following sub-accounts maintained on behalf of each Participant. (a) Money Purchase Pension Contributions, if any, plus any income and minus any loss thereon; Article I - Definitions February 6, 2002 -14-

(b) Nonelective Contributions, including any Nonelective Contributions that are ADP Test Safe Harbor Contributions, if any, plus any income and minus any loss thereon; (c) Matching Contributions, including any Matching Contributions that are ADP Test Safe Harbor Contributions, ACP Test Safe Harbor Matching Contributions, or True-Up Contributions, if any, plus any income and minus any loss thereon; (d) Qualified Nonelective Contributions, if any, plus any income and minus any loss thereon; (e) Qualified Matching Contributions, if any, plus any income and minus any loss thereon; (f) Prior Employer Contributions, if any, plus any income and minus any loss thereon; (g) Elective Deferral Contributions, if any, plus any income and minus any loss thereon; (h) Employee Contributions, if any, plus any income and minus any loss thereon; (i) QVEC Contributions, if any, plus any income and minus any loss thereon; (j) Rollover Contributions, if any, plus any income and minus any loss thereon. A Participant's Account shall be invested in accordance with rules established by the Plan Administrator that shall be applied in a consistent and nondiscriminatory manner. 1.46 PARTICIPANT'S EMPLOYER STOCK ACCOUNT. The term Participant's Employer Stock Account means that portion, if any, of the Participant's Account which is invested in shares of the Employer's stock. Such Participant's Employer Stock Account shall be credited with dividends paid, if any. Such Participant's Employer Stock Account will be valued on each day that the public exchange, over which the Employer's stock is traded, is open for unrestricted trading. In the event that the Employer's stock is not publicly traded, it shall be valued not less frequently than annually. Amounts that are invested in the Participant's Employer Stock Account may be invested in any short term account prior to actual investment in the Participant's Employer Stock Account. As elected by the Employer in the Adoption Agreement: (a) The Trustee will vote the shares of the Employer's stock invested in the Participant's Employer Stock Account; or (b) The Trustee will vote the shares of the Employer's stock in accordance with any instructions received by the Trustee from the Participant; or Article I - Definitions February 6, 2002 -15-

(c) The Trustee may request voting instructions from the Participants provided this is done in a consistent and nondiscriminatory manner. As elected by the Employer in the Adoption Agreement, the Employer may offer investment in, and Participants may invest in, shares of any or all Employers (as designated by the sponsoring Employer) that are part of the same controlled group of corporations or trades or business under common control as the sponsoring employer, whether or not a Participant is employed by that particular entity. Alternatively, as elected by the Employer in the Adoption Agreement, investment may be limited to the stock of the specific Employer or Adopting Employer that employees the Participant. The ability of a Participant who is subject to the reporting requirements of section 16(a) of the Securities Exchange Act of 1934 (the "Act") to make withdrawals or investment changes involving the Participant's Employer Stock Account may be restricted by the Plan Administrator to comply with the rules under section 16(b) of the Act. Effective January 1, 1999, plans that contain a CODA may invest no more than 10% of the Plan's assets attributable to elective deferrals Contributions in Employer stock, unless (a) Participants direct the investment in Employer stock, (b) an Elective Deferral Contribution of no more than 1% of Compensation (as defined in the Plan for purposes of making Elective Deferral Contributions) is required to be invested in Employer stock, or (c) on the last day of the preceding Plan Year, the fair market value of all assets in all the defined contribution plans of the Employer equal no more than 10% of all of the Employer's plans' assets (excluding any multiemployer plans). A money purchase pension plan making an initial investment in shares of the Employer's stock after December 31, 1974, may not acquire shares to the extent that the aggregate fair market value of the Employer's stock held by the Plan will exceed 10 percent of the fair market value of the assets of the Plan. 1.47 PARTNER. The term Partner means a member of a Partnership. 1.48 PARTNERSHIP. The term Partnership means a partnership as defined in Code section 7701(a)(2) and the regulations thereunder and includes a syndicate, group, pool, joint venture, or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on, and which is not a corporation or a trust or estate within the meaning of the Code. A joint undertaking merely to share expenses is not a Partnership. In addition, mere co-ownership of property which is maintained, kept in repair, and rented or leased does not constitute a Partnership. 1.49 PERSON. The term Person means any natural person, partnership, corporation, trust or estate. 1.50 PLAN. The term Plan means this Connecticut General Life Insurance Company Defined Contribution Plan and the Adoption Article I - Definitions February 6, 2002 -16-

Agreement as adopted by the Employer and as both may be amended from time to time. 1.51 PLAN ADMINISTRATOR. The term Plan Administrator means the Person or Persons designated by the Employer in its Adoption Agreement and any successor(s) thereto. If more than one Person shall be designated, the committee thus formed shall be known as the Administrative Committee and all references in the Plan to the Plan Administrator shall be deemed to apply to the Administrative Committee. The Plan Administrator shall signify in writing his acceptance of his responsibility as a Named Fiduciary. 1.52 PLAN YEAR. The term Plan Year means the 12-consecutive month period specified by the Employer in the Adoption Agreement. If the Plan Year changes to a different 12-consecutive month period, the first new Plan Year shall begin before the end of the last old Plan Year. In this event, the period beginning on the first day of the last old Plan Year and ending on the day before the first day of the first new Plan Year shall be treated as a short Plan Year for purposes of determining Highly Compensated Employees, performing the Nondiscrimination Tests set forth in Section 4A, and applying the Top-Heavy provisions of Section 7A. However, Service will be credited in accordance with the provisions of Section 2A.8. 1.53 PREVAILING WAGE LAW The term Prevailing Wage Law means any statute or ordinance that requires the Employer to pay its Employees working on public contracts at wage rates not less than those determined pursuant to that statute classes of workers in the geographical area where the contract is performed, including the Davis-Bacon Act and similar Federal, state, or municipal prevailing wage statutes. 1.54 PRIOR EMPLOYER CONTRIBUTIONS. The term Prior Employer Contributions means contributions of a type no longer allowed under the terms of this Plan and the Adoption Agreement made by the Employer prior to the date indicated on the Adoption Agreement. 1.55 PRIOR REQUIRED EMPLOYEE CONTRIBUTIONS The term Prior Required Employee Contributions means Employee post-tax contributions that the Employer required as either a condition of participation, or for receiving an Employer contribution, prior to the date indicated on the Adoption Agreement. 1.56 PRIOR VOLUNTARY EMPLOYEE CONTRIBUTIONS The term Prior Voluntary Employee Contributions means post-tax contributions made voluntarily by an Employee prior to the date indicated on the Adoption Agreement. 1.57 QDRO. The term QDRO means a Qualified Domestic Relations Order as determined in accordance with Code section 414(p) and regulations thereunder. 1.58 QUALIFIED MATCHING CONTRIBUTIONS. The term Qualified Matching Contributions means Matching Contributions which are subject to Article I - Definitions February 6, 2002 -17-

the distribution and nonforfeitability requirements of Code section 401(k) when made. 1.59 QUALIFIED NONELECTIVE CONTRIBUTIONS. The term Qualified Nonelective Contributions means Nonelective Contributions made by the Employer and allocated to Participants' accounts that the Participants may not elect to receive in cash until distributed from the Plan; that are nonforfeitable when made; and that are distributable only in accordance with the distribution provisions that are applicable to Elective Deferral Contributions and Qualified Matching Contributions. 1.60 QVEC CONTRIBUTIONS. The term QVEC Contributions means voluntary amounts contributed by the Participant prior to January 1, 1987, which the Participant designated in writing were eligible for a tax deduction under Code section 219(a). QVEC Contributions will be maintained in a separate account, which will be nonforfeitable (i.e., 100% vested) at all times. The account will share in the gains and losses under the Plan in the same manner as described in Section 5A.3 of the Plan. 1.61 REQUIRED EMPLOYEE CONTRIBUTIONS. The term Required Employee Contributions means Employee post-tax contributions that the Employer requires either as a condition of participation or for receipt of an Employer contribution. 1.62 ROLLOVER CONTRIBUTION. The term Rollover Contribution means an amount representing all or part of a distribution from a pension or profit sharing plan meeting the requirements of Code section 401(a), which is eligible for rollover to this Plan in accordance with the requirements set forth in Code section 402 (including Direct Rollovers) or Code section 408(d)(3), whichever is applicable. 1.63 SALARY DEFERRAL AGREEMENT. The term Salary Deferral Agreement means an agreement between a Participant and the Employer to defer receipt of a portion of the Participant's Compensation by making Elective Deferral Contributions to the Plan. If elected by the Employer in the Adoption Agreement, the term Salary Deferral Agreement shall also include a deemed election by an Employee to defer receipt of Compensation by making Elective Deferral Contributions to the Plan. 1.64 SELF-EMPLOYED INDIVIDUAL. The term Self-Employed Individual means an individual who has Earned Income for the taxable year from the trade or business for which the Plan is established; also, an individual who would have Earned Income but for the fact that the trade or business had no net profits for the taxable year. 1.65 SERIOUS FINANCIAL HARDSHIP. The term Serious Financial Hardship means an immediate and heavy financial need of the Participant where such Participant lacks the available resources to meet the hardship. The Plan Administrator shall make a determination of whether a Serious Financial Hardship exists in accordance with the applicable provisions of Section 3E. Article I - Definitions February 6, 2002 -18-

1.66 SHAREHOLDER-EMPLOYEE The term Shareholder-Employee means an Employee or officer of an electing small business S corporation who owns (or is considered as owning within the meaning of Code section 318(a)(1)), on any day during the taxable year of such corporation, more than 5% of the outstanding stock of the corporation. 1.67 SOCIAL SECURITY INTEGRATION LEVEL. The term Social Security Integration Level means the Social Security Taxable Wage Base or such lesser amount specified by the Employer in the Adoption Agreement. If the Social Security Taxable Wage Base is amended, the Social Security Integration Level will be deemed to have been amended. 1.68 SOCIAL SECURITY TAXABLE WAGE BASE. The term Social Security Taxable Wage Base means the contribution and benefit base in effect under section 230 of the Social Security Act at the beginning of the Plan Year. 1.69 SPONSORING ORGANIZATION. The term Sponsoring Organization means Connecticut General Life Insurance Company, a legal reserve life insurance company of Hartford, Connecticut. 1.70 SPOUSE. The term Spouse means the lawful wife of a male Participant, or the lawful husband of a female Participant. However, a former Spouse will be treated as the Spouse or surviving Spouse and a current Spouse will not be treated as the Spouse or surviving Spouse to the extent provided under a QDRO. 1.71 STRAIGHT LIFE ANNUITY. The term Straight Life Annuity means an annuity payable in equal installments for the life of the Participant, and that terminates upon the Participant's death. 1.72 TERMINATION OF EMPLOYMENT. The term Termination of Employment means a severance of the Employer-Employee relationship which occurs prior to a Participant's Normal Retirement Age for any reason other than Early Retirement, Disability, or death. 1.73 TRUE-UP CONTRIBUTIONS. The term True-Up Contributions means Matching Contributions made to the Plan by the Employer so that total Matching Contributions for each Participant are calculated on an annual basis rather than on the basis selected by the Employer in the Adoption Agreement. 1.74 TRUST. The term Trust means the Trust Agreement if the Employer specifies in the Adoption Agreement that the Plan is Trusteed. The Trust Agreement is entered into by the Employer, the Plan Administrator and the Trustee by completing and signing the Adoption Agreement, which Trust Agreement forms a part of, and implements the provisions of the Plan as it applies to the Employer. If the Employer specifies in the Adoption Agreement that the Plan is Non-Trusteed, then the terms and provisions of this Plan relating to the Trust shall be of no force and effect. 1.75 TRUSTEE. The term Trustee means the trustee(s) designated by the Employer in its Adoption Agreement, if applicable, and any successor(s) thereto. Article I - Definitions February 6, 2002 -19-

1.76 VESTED INTEREST. The term Vested Interest means the nonforfeitable right to an immediate or deferred benefit on any date in the amount which is equal to the sum of (a), (b) and (c) below: (a) The value on that date of that portion of the Participant's Account that is attributable to and derived from Employee Contributions, if any; (b) The value on that date of the portion of the Participant's Account attributable to Elective Deferral Contributions, if any; Qualified Nonelective Contributions, if any; QVEC Contributions, if any; Rollover Contributions, if any; ADP Test Safe Harbor Contributions, if any; ACP Test Safe Harbor Matching Contributions, if any; and Qualified Matching Contributions, if any; (c) The value on that date of that portion of the Participant's Account that is attributable to and derived from contributions made by the Employer (and Forfeitures, if any), multiplied by his Vesting Percentage determined on the date applicable. Employer contributions described in subsection (c), plus the earnings thereon, shall be, at any relevant time, a part of the Participant's Vested Interest equal to an amount ("X") determined by the following formula: X = P (AB + D) - D For purposes of applying this formula: P = The Participant's Vesting Percentage at the relevant time. AB = The account balance attributable to such contributions, plus the earnings there on, at the relevant time. D = The amount of any distribution. A deemed distribution shall not be treated as an actual distribution for purposes of applying this calculation. The amount of any deemed distribution shall not be included in "D." 1.77 VESTING PERCENTAGE. The term Vesting Percentage means the Participant's nonforfeitable interest in Money Purchase Pension Contributions, Matching Contributions, Nonelective Contributions, or Prior Employer Contributions credited to his Participant's Account, plus any income and minus any loss thereon. The Vesting Percentage for each such Employer contribution is computed in accordance with one of the schedules listed below, based on Years of Service with the Employer, as specified by the Employer in its Adoption Agreement: (a) 100% full and immediate; (b) 100% after 3 Years of Service; Article I - Definitions February 6, 2002 -20-

(c) 20% per Year of Service, 100% at 5 Years of Service; (d) 20% after 3 Years of Service, 20% per Year of Service thereafter, 100% at 7 Years of Service; (e) 20% after 2 Years of Service, 20% per Year of Service thereafter, 100% at 6 Years of Service; (f) 100% after 5 Years of Service; (g) 25% after 1 Year of Service, 100% after 4 Years of Service; (h) Other. However, if a Participant dies prior to attaining his Normal Retirement Age, his Vesting Percentage shall be 100%. Any Employer Contributions under the Plan made pursuant to the Davis-Bacon Act or any other prevailing wage law shall always have a vesting percentage of 100%. 1.78 VOLUNTARY EMPLOYEE CONTRIBUTIONS. The term Voluntary Employee Contributions means post-tax contributions made voluntarily by an Employee. Article I - Definitions February 6, 2002 -21-

ARTICLE II - GENERAL PROVISIONS 2A. SERVICE 2A.1 SERVICE. The term Service means active employment with the Employer as an Employee. Service shall be credited for purposes of Eligibility, Contributions, and Benefits with respect to qualified military service in accordance with section 414(u) of the Internal Revenue Code. 2A.2 ABSENCE FROM EMPLOYMENT. Absence from employment on account of a leave of absence authorized by the Employer pursuant to the Employer's established leave policy will be counted as employment with the Employer provided that such leave of absence is of not more than two years' duration. Absence from employment on account of active duty with the Armed Forces of the United States will be counted as employment with the Employer. Service will be credited for any qualified military service as required by Code section 414(u). If the Employee does not return to active employment with the Employer, his Service will be deemed to have ceased on the date the Plan Administrator receives notice that the Employee will not return. The Employer's leave policy shall be applied in a uniform and nondiscriminatory manner to all Participants under similar circumstances. For purposes of determining an Employee's eligibility and vesting status for periods while the Employee is absent from work for reasons covered under the Family and Medical Leave Act, Service will be credited in accordance with and to the extent required by the provisions of the Family and Medical Leave Act. IF THE EMPLOYER HAS ELECTED IN THE ADOPTION AGREEMENT TO DETERMINE SERVICE BASED UPON 1,000 HOURS, THEN THE FOLLOWING SECTIONS 2A.3 THROUGH 2A.8 SHALL APPLY. 2A.3 HOUR OF SERVICE. The term Hour of Service means: (a) Each hour for which an Employee is directly or indirectly paid, or entitled to payment, by the Employer for the performance of duties. These hours shall be credited to the Employee for the Computation Period or Periods, as defined in Section 2A.5, in which the duties were performed; and (b) Each hour for which an Employee is paid or entitled to payment, by the Employer on account of a period of time during which no duties are performed (irrespective of whether the employment relationship has terminated) due to vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence. No more than 501 Hours of Service will be credited under this paragraph for a single Computation Period (whether or not the period occurs in a single Computation Period). Hours under this paragraph will be Article II - General Provisions February 6, 2002 -22-

calculated and credited pursuant to section 2530.200b-2 of the Department of Labor regulations which are incorporated herein by this reference; and (c) Each hour for which back pay, irrespective of mitigation of damages, has been either awarded or agreed to by the Employer. The same Hours of Service will not be credited under subsection (a) or subsection (b), as the case may be, and under this subsection (c). These hours shall be credited to the Employee for the Computation Period or periods to which the award or agreement pertains rather than the Computation Period in which the award, agreement or payment is made; and Hours of Service will be credited for employment with other members of an affiliated service group (under Code section 414(m)), a controlled group of corporations (under Code section 414(b)), or a group of trades or businesses under common control (under Code section 414(c)), of which the adopting Employer is a member, and any other entity required to be aggregated with the Employer pursuant to Code section 414(o). (d) Each hour of qualified military service as defined in Code section 414(u)(5). Hours of Service will also be credited for any individual considered an Employee for purposes of this Plan under Code sections 414(n) or 414(o). Solely for purposes of determining whether a 1-Year Break-in-Service, as defined in Section 2A.4, for participation and vesting purposes has occurred in a Computation Period, an individual who is absent from work for maternity or paternity reasons shall receive credit for the Hours of Service which would otherwise have been credited to such individual but for such absence, or in any case in which such hours cannot be determined, eight (8) Hours of Service per day of such absence. For purposes of this paragraph, an absence from work for maternity or paternity reasons means an absence (1) by reason of the pregnancy of the individual, (2) by reason of a birth of a child of the individual, (3) by reason of the placement of a child with the individual in connection with the adoption of such child by such individual, or (4) for purposes of caring for such child for a period beginning immediately following such birth or placement. The Hours of Service credited under this paragraph shall be credited (1) in the Computation Period in which the absence begins if the crediting is necessary to prevent a Break-in-Service in that period, or (2) in all other cases, in the following Computation Period. Service shall be determined on the basis of the method selected in the Adoption Agreement. 2A.4 1-YEAR BREAK-IN-SERVICE. The term 1-Year Break-in-Service means any Computation Period during which an Employee fails to complete more than 500 Hours of Service. Article II - General Provisions February 6, 2002 -23-

2A.5 YEAR(S) OF SERVICE. The term Year(s) of Service means a 12-consecutive month period ("Computation Period") during which an Employee has completed at least 1,000 Hours of Service. (a) Eligibility Computation Period. For purposes of determining Years of Service and Breaks-in-Service for eligibility, the 12-consecutive month period shall begin with the date on which the Employee first performs an Hour of Service for the Employer and, where additional periods are necessary, as elected in the Adoption Agreement, either succeeding anniversaries of his employment commencement date or the Plan Year beginning within the Employee's initial 12-consecutive month period of employment and, if necessary, succeeding anniversaries thereof. The employment commencement date is the date on which the Employee first performs an Hour of Service for the Employer maintaining the Plan. (b) Vesting Computation Period. As elected by the Employer in the Adoption Agreement, for computing Years of Service and Breaks-in-Service for vesting, the 12-consecutive month period: (1) Shall be the Plan Year; or (2) Shall begin with the date on which the Employee first performs an Hour of Service for the Employer and, where additional periods are necessary, succeeding anniversaries of that date. However, active participation as of the last day of the Plan Year is not required in order for a Participant to be credited with a Year of Service for vesting purposes. (c) Contribution Computation Period. If the Employer specifies an annual Contribution Period in its Adoption Agreement for the purpose of determining a Participant's eligibility to receive a contribution, the 12-consecutive month period shall be any Plan Year during which the Participant is credited with at least 1,000 Hours of Service. However, when an Employee first becomes a Participant or resumes active participation in the Plan following a 1-Year Break-in-Service on a date other than the first day of the Plan Year, all Hours of Service credited to the Participant during that Plan Year, including those Hours credited prior to the date the Employee enrolls (or reenrolls) as an Participant in the Plan shall be counted. Furthermore, the Employer may require in its Adoption Agreement that a Participant be a Participant as of the last day of the Plan Year in order to be eligible to receive a contribution for a Plan Year. (d) If in its Adoption Agreement the Employer permits Early Retirement, the 12-consecutive month period for determining Early Retirement shall be the Plan Year. However, active participation as of the last day of the Plan Year is not required in order for a Participant to be credited with a Year of Service. Article II - General Provisions February 6, 2002 -24-

Service with a predecessor organization of the Employer shall be treated as Service with the Employer for the purposes of subsections (a), (b) and (d) above in any case in which the Employer maintains the plan of such predecessor organization. In addition, if elected by the Employer in the Adoption Agreement, service with a predecessor organization of the Employer shall be treated as Service with the Employer, even if the Employer does not maintain the plan of such predecessor organization. If elected in the Adoption Agreement, service with a subsidiary or affiliate of the Employer that is not related to the Employer under the provisions of Code sections 414(b), (c) or (m) shall be treated as Service with the Employer for purposes of (a), (b) and (d) above. 2A.6 DETERMINING VESTING PERCENTAGE. Vesting credit shall be given for each Year of Service except those periods specifically excluded in the Adoption Agreement. If a Participant completes less than 1,000 Hours of Service during a Plan Year while remaining in the service of the Employer, his Vesting Percentage shall not be increased for such Plan Year. However, at such time as the Participant again completes at least 1,000 Hours of Service in any subsequent Plan Year, his Vesting Percentage shall then take into account all Years of Service with the Employer except those specifically excluded in the Adoption Agreement. If an individual who ceases to be an Employee and is subsequently rehired as an Employee enrolls (or reenrolls) in the Plan, upon his participation (or reparticipation) his Vesting Percentage shall then take into account all Years of Service except those specifically excluded in the Adoption Agreement. In the case of a Participant who has 5 consecutive 1-Year Breaks-in-Service, all Years of Service after such Breaks-in-Service will be disregarded for the purpose of vesting the Employer-derived account balance that accrued before such breaks. However, both pre-break and post-break Service will count for the purpose of vesting the Employer-derived account balance that accrues after such Breaks-in-Service. Both accounts will share in the earnings and losses of the fund. In the case of a Participant who does not have 5-consecutive 1-Year Breaks-in-Service, both the pre-break and post-break Service will count in vesting both the pre-break and post-break Employer-derived account balance. 2A.7 EXCLUDED YEARS OF SERVICE FOR VESTING. In determining the Vesting Percentage of an Employee, all Years of Service with the Employer(s) maintaining the Plan shall be taken into account, except that the following periods may be excluded, as specified by the Employer in its Adoption Agreement: (a) Years of Service prior to the time a Participant attained age 18; Article II - General Provisions February 6, 2002 -25-

(b) Years of Service during which the Employer did not maintain the Plan or a predecessor plan; (c) Years of Service during a period for which the Employee made no Required Employee Contributions; (d) Years of Service prior to any 1-Year Break-in-Service, until the Employee completes one Year of Service following such 1-Year Break-in-Service. (e) In the case of an Employee who has no Vested Interest in Employer contributions, Years of Service before any period of consecutive 1-Year Breaks-in-Service if the number of such consecutive 1-Year Breaks-in-Service equals or exceeds the greater of (i) 5, or (ii) the total number of Years of Service before such break. For the purposes of this Section, a predecessor plan shall mean a plan of the Employer that was terminated within five years preceding or following the Effective Date of this Plan. 2A.8 CHANGE IN PLAN YEARS. If the Plan Year is changed, the following special rules shall apply. (a) Vesting Computation Periods. If the Vesting Computation Period is the Plan Year, Years of Service and 1-Year Breaks-in-Service shall be measured over two overlapping 12-consecutive month periods. The first such period shall begin on the first day of the last old Plan Year and the second such period shall begin on the first day of the first new Plan Year, thereby creating an overlap. All Hours of Service performed during the overlap period must be counted in both Vesting Computation Periods. A Participant who completes at least 1,000 Hours of Service during each such period shall be credited with two Years of Service for Vesting. (b) Contribution Computation Periods. To determine a Participant's eligibility to receive a contribution for a short Plan Year, the 1,000 Hours of Service requirement shall be prorated by multiplying by a fraction, the numerator of which is the number of full months in the short Plan Year and the denominator of which is 12. Article II - General Provisions February 6, 2002 -26-

IF THE EMPLOYER HAS ELECTED IN THE ADOPTION AGREEMENT TO DETERMINE SERVICE BASED UPON ELAPSED TIME, THEN THE FOLLOWING SECTIONS 2A.9 AND 2A.10 SHALL APPLY. 2A.9 ELAPSED TIME. If the Employer has selected an eligibility or vesting requirement in the Adoption Agreement that is or includes a fractional Year(s) of Service requirement, or applies elapsed time provisions to a full year service requirement, the provisions of this Section shall apply. (a) For purposes of determining an Employee's initial or continued eligibility to participate in the Plan, or the Participant's Vested Interest in Employer contributions, an Employee will receive credit for the aggregate of all time period(s) commencing with the Employee's first day of employment or reemployment and ending on the date a Break-in-Service (as defined in this Section) begins. The first day of employment or reemployment is the first day the Employee performs an Hour of Service. An Employee will also receive credit for any Period of Severance of less than 12-consecutive months. Fractional periods of a year will be expressed in terms of days. (b) For purposes of this Section, "Hour of Service" shall mean each hour for which an Employee is paid or entitled to payment for the performance of duties for the Employer, and each hour of qualified military service as defined in Code section 414(u)(5). (c) For purposes of this Section, a "Break-in-Service" is a Period of Severance of at least 12 consecutive months. (d) A "Period of Severance" is a continuous period of time during which the Employee is not employed by the Employer. Such period begins on the date the Employee retires, quits or is discharged, or if earlier, the 12-month anniversary of the date on which the Employee was otherwise first absent from Service. (e) In the case of an individual who is absent from work for maternity or paternity reasons, the 12-consecutive month period beginning on the first anniversary of the first day of such absence shall not constitute a Break-in-Service. For purposes of this paragraph, an absence from work for maternity or paternity reasons means an absence (1) by reason of the pregnancy of the individual, (2) by reason of the birth of a child of the individual, (3) by reason of the placement of a child with the individual in connection with the adoption of such child by such individual, or (4) for purposes of caring for such child for a period beginning immediately following such birth or placement. Each Employee will share in Employer contributions for the period beginning on the date the Employee commences participation under the Plan and ending on the date on which such Employee severs employment with the Employer or is no longer a member of an eligible class of Employees. Article II - General Provisions February 6, 2002 -27-

(f) If the Employer is a member of an affiliated service group (under Code section 414(m)), a controlled group of corporations (under Code section 414(b)), a group of trades or businesses under common control (under Code section 414(c)) or any other entity required to be aggregated with the Employer pursuant to Code section 414(o), Service will be credited for any employment for any period of time for any other member of such group. Service will also be credited for any individual required under Code section 414(n) or Code section 414(o) to be considered an Employee of any Employer aggregated under Code sections 414(b), (c), or (m) of such group. 2A.10 EXCLUDED PERIODS OF SERVICE FOR VESTING. In determining the Vesting Percentage of an Employee, all Periods of Service with the Employer(s) maintaining the Plan shall be taken into account, except that the following periods may be excluded, as specified by the Employer in its Adoption Agreement: (a) Periods of Service prior to the time a Participant attained age 18; (b) Periods of Service during which the Employer did not maintain the Plan or a predecessor plan; (c) Periods of Service during which the Employee made no Required Employee Contributions; (d) Periods of Service prior to any one-year Period of Severance, until the Employee completes a one-year period of Service following such Period of Severance; (e) In the case of an Employee who has no Vested Interest in Employer contributions, Periods of Service before any Period of Severance if the number of consecutive one-year Periods of Severance equals or exceeds the greater of (i) 5, or (ii) the total number of one-year Periods of Service before such Period of Severance. For the purposes of this Section, a predecessor plan shall mean a plan of the Employer that was terminated within five years preceding or following the Effective Date of this Plan. 2B. ELIGIBILITY, ENROLLMENT AND PARTICIPATION 2B.1 ELIGIBILITY. Each Employee shall be eligible to participate in the Plan and receive an appropriate allocation of Employer contributions as of the Entry Date following the day he meets the following requirements, if any, specified by the Employer in its Adoption Agreement, relating to: (a) Required service; (b) Minimum attained age; (c) Job class requirements. Article II - General Provisions February 6, 2002 -28-

In addition to the eligibility conditions stated above, the Employer may specify in the Adoption Agreement certain groups of Employees who are not eligible to participate in the Plan. Notwithstanding the foregoing, if the Employer's Plan as set forth herein replaces or amends a preceding plan, then those Employees participating under the Plan as written prior to such replacement or amendment shall be eligible to be Participants hereunder without regard to length of Service or minimum attained age otherwise required herein. There shall be no required service or minimum attained age requirements for any Employer Contributions under the Plan made pursuant to the Davis Bacon Act or any other Prevailing Wage Law. 2B.2 ENROLLMENT. Each eligible Employee may enroll as of his Entry Date by completing and delivering to the Plan Administrator an enrollment form and, if applicable, a payroll deduction authorization and/or a Salary Deferral Agreement. If deemed elections by Employees for Elective Deferral Contributions are elected by the Employer in the Adoption Agreement, such Employees shall become Participants and shall be deemed to have enrolled in the Plan as of the date Elective Deferral Contributions begin. 2B.3 REEMPLOYMENT. In the case of an individual who ceases to be an Employee and is subsequently rehired as an Employee, the following provisions shall apply in determining eligibility to again participate in the Plan: (a) If the Employee had met the eligibility requirements as specified in Section 2B.1, such Employee will become a Participant in the Plan in accordance with Section 2B.2 as of the date he is reemployed as an Employee. (b) If the Employee had not formerly met the eligibility requirements specified in Section 2B.1, such Employee will become a Participant in the Plan after meeting the requirements of Section 2B.1 in accordance with Section 2B.2. 2B.4 ELIGIBLE CLASS. If a Participant becomes ineligible to participate because he is no longer a member of an eligible class of Employees, such Employee shall participate immediately upon his return to an eligible class of Employees. If such Participant incurs a Break-in-Service, eligibility will be determined under the Break-in-Service rules of the Plan. If an Employee who is not a member of the eligible class of Employees becomes a member of the eligible class, such Employee shall participate immediately if such Employee has satisfied the minimum age and Service requirements and would have previously become a Participant had he been in the eligible class. If such Participant incurs a Break-in-Service, eligibility will be determined under the Break-in-Service rules of the Plan. Article II - General Provisions February 6, 2002 -29-

2B.5 WAIVER OF PARTICIPATION. Notwithstanding any provision of the Plan to the contrary, if Required Employee Contributions are elected by the Employer in the Adoption Agreement, any Employee in accordance with the rules of the Plan may decline to become a Participant by filing a written waiver of participation with the Plan Administrator in the manner prescribed. An Employee may make a one-time irrevocable waiver of participation upon the later of his commencement of employment with the Employer or the date he is first eligible to participate in the Plan. Any Employee who files such a waiver shall not become a Participant and such Employee shall not receive any additional Compensation or other sums by reason of his waiver of participation. No Employee who is eligible to participate in a standardized plan may waive participation or voluntarily reduce his or her Compensation for purposes of this Plan. 2C. CONTRIBUTIONS AND ALLOCATIONS 2C.1 PROFIT SHARING/THRIFT PLAN WITH 401(k) FEATURE. (a) Contributions - Employer. For each Plan Year, as specified in the Adoption Agreement, the Employer shall make one or more of the following contributions. (1) Elective Deferral Contributions. (2) Matching Contributions. (3) Nonelective Contributions. (b) Contributions - Participant. For Plans that contain a CODA, for each Plan Year, as specified in the Adoption Agreement, each Participant may make periodic Required Employee Contributions or Voluntary Employee Contributions. For Plans that contain a CODA, a Participant may elect to make a Voluntary Employee Contribution in a lump sum. Such lump sum Voluntary Employee Contribution may be made (1) as of the Effective Date, or (2) as elected by the Employer in the Adoption Agreement. Voluntary Employee Contributions shall be subject to the terms of Section 4B. Article II - General Provisions February 6, 2002 -30-

(c) Fail-Safe Contribution. The Employer reserves the right to make a discretionary Nonelective Contribution to the Plan for any Plan Year, if the Employer determines that such a contribution is necessary to ensure the Actual Deferral Percentage test or the Actual Contribution Percentage test will be satisfied for that Plan Year, and provided the Employer has elected in the Adoption Agreement to use the Current Year Testing method. Such amount shall be designated by the Employer at the time of contribution as a Qualified Nonelective Contribution and shall be known as a Fail-Safe Contribution. The Fail-Safe Contribution must be allocated as of a date within the plan year to which it relates and must be paid to the Trust by the last day of the 12-month period following the Plan Year to which it relates. The Fail-Safe Contribution shall be made on behalf of all eligible non-Highly Compensated Employees who are Participants and who are considered under the Actual Deferral Percentage test or, if applicable, the Actual Contribution Percentage test, and shall be allocated to the Participant's Account of each such Participant in an amount equal to a fixed percentage of such Participant's Compensation. The fixed percentage shall be equal to the minimum fixed percentage necessary to be contributed by the Employer on behalf of each eligible non-Highly Compensated Employee who is a Participant so that the Actual Deferral Percentage test or, if applicable, the Actual Contribution Percentage test, is satisfied. (d) USERRA Contribution. An Employee who is reemployed following a period of qualified military service (as defined in Code section 414(u)) shall be entitled to make up Elective Deferral Contributions and Voluntary Employee Contributions, and to receive related Matching Contributions and Nonelective Contributions to the extent required by Code section 414(u). (e) Contributions - Changes. For each Plan Year, a Participant may change the amount of his Required Employee Contributions, Voluntary Employee Contributions, or Elective Deferral Contributions as often as the Plan Administrator allows (on a consistent and nondiscriminatory basis), on certain dates prescribed by the Plan Administrator. (f) Contributions - Timing. (1) Elective Deferral Contributions shall be paid by the Employer to the Trust or the Insurance Company, as elected by the Employer in the Adoption Agreement, but never later than 15 days after the close of the month in which they were deferred. Article II - General Provisions February 6, 2002 -31-

(2) Matching Contributions made on other than an annual basis shall be paid to the Trust or Insurance Company, as elected by the Employer in the Adoption Agreement. Matching Contributions, including Additional Matching Contributions, made on an annual basis shall be paid to the Trust or the Insurance Company, as applicable, at the end of the Plan Year, or as soon as possible on or after the last day of such Plan Year, but in no event later than the date prescribed by law for filing the Employer's income tax return, including any extension thereof. To the extent that Matching Contributions are used to purchase Life Insurance Policies, then such contributions for any Plan Year may be paid to the Trust when premiums for such Policies are due during the Plan Year. (3) Nonelective Contributions made on other than an annual basis shall be paid to the Trust or Insurance Company, as applicable, as elected by the Employer in the Adoption Agreement. Nonelective Contributions, including Additional Nonelective Contributions, made on an annual basis shall be paid to the Trust or the Insurance Company, as applicable, at the end of the Plan Year, or as soon as possible on or after the last day of such Plan Year, but in any event not later than the date prescribed by law for filing the Employer's income tax return, including any extension thereof. To the extent that Nonelective Contributions are used to purchase Life Insurance Policies, then such contributions for any Plan Year may be paid to the Trust when premiums for such Policies are due during the Plan Year. (4) Employee Contributions shall be transferred by the Employer to the Trust or the Insurance Company, as elected by the Employer in the Adoption Agreement, but never later than 15 days following the close of the month in which such contributions are made by the Employee. (5) The Fail-Safe Contribution for any Plan Year as determined above shall be paid to the Insurance Company at the end of the Plan Year, or as soon as possible on or after the last day of such Plan Year, but in no event later than the date which is prescribed by law for filing the Employer's income tax return, including any extensions thereof. (g) Contributions - Allocations. The allocation of Nonelective Contributions shall be made in accordance with (1), (2), (3), (4) or (5) below, as specified by the Employer in the Adoption Agreement. (1) Formula A: Compensation Ratio - Not Integrated with Social Security. Article II - General Provisions February 6, 2002 -32-

The allocation to each Participant shall be made in the proportion that the Compensation paid to each Participant eligible to receive an allocation bears to the Compensation paid to all Participants eligible to receive an allocation. (2) Formula B: Integrated with Social Security - Step Rate Method. Base Contribution: An amount equal to a percentage (as specified in the Adoption Agreement) of the Compensation of each Participant up to the Social Security Integration Level; Excess Contribution: In addition, an amount equal to a percentage (as specified in the Adoption Agreement) of the Participant's Compensation which is in excess of the Social Security Integration Level, subject to the Limitations on Allocations in accordance with Section 4B. This Excess Contribution percentage shall not exceed the lesser of: (A) twice the Base Contribution or (B) the Base Contribution plus the greater of: (i) the old age insurance portion of the Old Age Survivor Disability (OASDI) tax rate; or (ii) 5.7%. If the Employer has elected in the Adoption Agreement to use a Social Security Integration Level that in any Plan Year is the greater of $10,000 or 20% but less than 100% of the Social Security Taxable Wage Base, then the 5.7% limitation specified in 2C.1(f)(2)(B)(ii) shall be adjusted in accordance with the following table: IF THE SOCIAL SECURITY INTEGRATION LEVEL is more But not more Adjust than Than 5.7% to - ------------------------------------------------------------------------ the greater of $10,000 or 80% of the Social Security 4.3% 20% of the Social Security Taxable Wage Base Taxable Wage Base 80% of the Social Security 100% of the Social Security 5.4% Taxable Wage Base Taxable Wage Base In the case of any Participant who has exceeded the Cumulative Permitted Disparity Limit described in Section 2C.1(g), Nonelective Contributions shall be Article II - General Provisions February 6, 2002 -33-

allocated in an amount equal to the Excess Contribution percentage of two times such Participant's total Compensation for the Plan Year. Any remaining Nonelective Contributions or Forfeitures will be allocated to each Participant's Account in the ratio that each Participant's total Compensation for the Plan Year bears to all Participants' total Compensation for that Plan Year. (3) Formula B: Integrated with Social Security - Maximum Disparity Method. Subject to the Limitations on Allocations specified in Section 4B, for each Plan Year the allocation to each Participant shall be made in accordance with the following: (A) An amount equal to 5.7% of the sum of each Participant's total Compensation plus Compensation that is in excess of the Social Security Integration Level shall be allocated to each Participant's Account. If the Employer does not contribute such amount for all Participants, an amount shall be allocated to each Participant's Account equal to the same proportion that each Participant's total Compensation plus Compensation that is in excess of the Social Security Integration Level bears to the total Compensation plus Compensation in excess of the Social Security Integration Level of all Participants in the Plan. In the case of any Participant who has exceeded the Cumulative Permitted Disparity Limit described in Section 2C.1(g), two times such Participant's total Compensation for the Plan Year will be taken into account. If the Employer has elected in the Adoption Agreement to use a Social Security Integration Level that in any Plan Year is the greater of $10,000 or 20% but less than 100% of the Social Security Taxable Wage Base, then the 5.7% limitation specified in this subsection shall be adjusted in accordance with the following table: IF THE SOCIAL SECURITY INTEGRATION LEVEL is more But not more Adjust than Than 5.7% to - ------------------------------------------------------------------------ the greater of $10,000 or 80% of the Social Security 4.3% 20% of the Social Security Taxable Wage Base Taxable Wage Base 80% of the Social Security 100% of the Social Security 5.4% Taxable Wage Base Taxable Wage Base Article II - General Provisions February 6, 2002 -34-

(B) The balance of the Nonelective Contribution (if any), shall be allocated to the Participant's Account in the proportion that each Participant's Compensation bears to the total Compensation of all Participants. (4) Formula C: Flat Dollar Amount. The allocation to each Participant shall be a flat dollar amount as elected by the Employer in the Adoption Agreement. (5) Formula D: Uniform Points Allocation. The allocation to each Participant shall be based on a Uniform Points Allocation as elected by the Employer in the Adoption Agreement. Formula D may not be used under a Standardized plan. (h) Allocation Requirements. Employer contributions shall be allocated to the accounts of Participants in accordance with the allocation requirement as specified by the Employer in its Adoption Agreement. If the Employer has adopted a standardized plan, the allocation of any nonannual contribution made by the Employer shall be made to each Participant who is a Participant on any day of the Contribution Period regardless of Hours of Service. Annual Overall Permitted Disparity Limit. Notwithstanding the preceding paragraph, for any Plan Year this Plan benefits any Participant who benefits under another qualified plan or simplified employee pension plan, as defined in Code section 408(k), maintained by the Employer that provides for permitted disparity (or imputes disparity), Employer contributions and Forfeitures will be allocated to the account of each Participant who either completes more than 500 Hours of Service during the Plan Year or who is employed as of the last day of the Plan Year in the ratio that such Participant's total Compensation bears to the total Compensation of all Participants. Cumulative Permitted Disparity Limit. Effective for Plan Years beginning on or after January 1, 1995, the Cumulative Permitted Disparity Limit for a Participant is 35 total cumulative permitted disparity years. Total cumulative permitted years mean the number of years credited to the Participant for allocation or accrual purposes under this Plan, any other qualified plan or simplified employee pension plan (whether or not terminated) ever maintained by the Employer. For purposes of determining the Participant's Cumulative Permitted Disparity Limit, all years ending in the same calendar year are treated as the same year. If the Participant has not benefited under a defined benefit or Article II - General Provisions February 6, 2002 -35-

target benefit plan for any year beginning on or after January 1, 1994, the Participant has no Cumulative Permitted Disparity Limit. (i) Forfeitures. Forfeitures will be used in the manner elected in the Adoption Agreement as follows: (1) Allocated in accordance with the allocation formula elected in the Adoption Agreement for the contributions from which the Forfeitures were generated; or (2) First, to reduce Employer contributions or pay Plan expenses, with any remaining Forfeitures allocated in accordance with the allocation formula elected in the Adoption Agreement for the contributions from which the Forfeitures were generated. (j) Expenses. The Employer may contribute to the Plan the amount necessary to pay any reasonable expenses of administering the Plan. In lieu of the Employer contributing the amount necessary to pay such charges, these expenses may be paid from Plan assets. (k) Special Rules - Elective Deferral Contributions. (1) Each Participant may elect (or shall be deemed to have elected if the Employer has elected deemed elections by Participants in the Adoption Agreement) to defer his Compensation in an amount specified in the Adoption Agreement, subject to the limitations of this Section. A Salary Deferral Agreement (or modification of an earlier Salary Deferral Agreement) may not be made with respect to Compensation which is currently available on or before the date the Participant executed such election, or if later, the later of the date the Employer adopts this CODA, or the date such arrangement first becomes effective. Any elections made pursuant to this Section shall become effective as soon as administratively feasible. (2) Elective Deferral Contributions will be allocated to the Participant's Account and shall be 100 percent vested and nonforfeitable at all times. (3) During any taxable year, no Participant shall be permitted to have Elective Deferral Contributions made under this Plan, or any other qualified plan maintained by the Employer, in excess of the dollar limitation contained in Code section 402(g) in effect at the beginning of such taxable year. If a Participant takes a withdrawal of Elective Deferral Contributions due to a Serious Financial Hardship, as provided in Section 3E.5, his Elective Deferral Article II - General Provisions February 6, 2002 -36-

Contributions for his taxable year immediately following the taxable year of such distribution may not exceed the Code section 402(g) limit for such taxable year less the amount of Elective Deferral Contributions made for the Participant in the taxable year of the distribution. (4) Elective Deferral Contributions that are not in excess of the limits described in subsection (3) above shall be subject to the Limitations on Allocations in accordance with Section 4B. Elective Deferral Contributions that are in excess of the limits described in (3) above shall also be subject to the Section 4B limitations, as further provided in Section 4C.2. (5) An Employee's eligibility to make Elective Deferral Contributions under a CODA may not be conditioned upon the completion of more than one (1) Year-of-Service or the attainment of more than age twenty-one (21). (6) A Participant may modify the amount of Elective Deferral Contributions such Participant makes to the Plan as often as the Plan Administrator allows, as specified in the Adoption Agreement, but in no event not less frequently than once per calendar year. Such modification may be made by filing a written notice with the Plan Administrator within the time period prescribed by the Plan Administrator. (l) Safe Harbor 401(k) Plans - Special Rules. (1) If elected by the Employer in the Adoption Agreement, the Employer may establish a Safe Harbor 401(k) Plan, and the provisions of this section 2.C.1(l) shall apply for the Plan Year and any other provisions relating to the ADP Test or ACP Test shall not apply. Notwithstanding the foregoing, to the extent that the Employer elects in the Adoption Agreement to make Matching Contributions or Nonelective Contributions that do not meet the requirements of this section 2.C.1(l), then the other provisions of this Plan relating to such contributions shall apply thereto. Moreover, any such contributions shall be required to meet the Actual Contribution Percentage test requirements using Current Year Testing methods. In addition, if the Employer elects in the Adoption Agreement to allow Participants to make Voluntary Employee Contributions or Required Employee Contributions, the Safe Harbor 401(k) rules shall not apply to these contributions. Any such contributions shall be required to meet the Actual Contribution Percentage test requirements. If the Employer elects in the Adoption Agreement to establish a Safe Harbor 401(k) Plan, the election must Article II - General Provisions February 6, 2002 -37-

apply to all Eligible Employees under the Plan even if they comprise two or more groups of Employees who, but for this election, must be mandatorily disaggregated for nondiscrimination testing. (2) To the extent that any other provision of the Plan is inconsistent with the provisions of this section, the provisions of this section shall apply to a Safe Harbor 401(k) Plan. (3) Definitions. (A) ACP Test Safe Harbor. ACP Test Safe Harbor is the method described in section 2.C.1(l)(5) for satisfying the Actual Contribution Percentage Test. (B) ACP Test Safe Harbor Matching Contributions. ACP Test Safe Harbor Matching Contributions are matching contributions described in section 2.C.1(l)(5) of the Plan. (C) ADP Test Safe Harbor. ADP Test Safe Harbor is the method described in section 2.C.1(l)(4) for satisfying the Actual Deferral Percentage Test. (D) ADP Test Safe Harbor Contributions. ADP Test Safe Harbor Contributions are matching contributions and nonelective contributions described in section 2.C.1(l)(4) of the Plan. (E) Compensation. Compensation is as defined in section 1.13 of the Plan, except that for purposes of this section 2.C.1(l), no dollar limit, other than that imposed by Code section 401(a)(17), may apply to a Nonhighly Compensated Employee. To the extent that an Employer elects to use a reasonable alternative definition of Compensation, as defined in section 1.13(I), for determining the Compensation subject to a Participant's elective deferral election, that definition must permit each Employee to elect sufficient Elective Deferrals to receive the maximum amount of any Matching Contributions available to the Participant under the Plan. (F) Eligible Employee. Eligible Employee means any Employee eligible to make Elective Deferral Contributions under the Plan for any part of the Plan Year, or who would be eligible but for a suspension due to a Serious Financial Hardship Withdrawal described in section 3.E.7(b) of the Plan, or any statutory limitation, such as that imposed under sections 402(g) and 415 of the Code. (G) Matching Contributions. Matching Contributions are contributions made by the Employer on account of an Eligible Employee's Elective Deferral Contributions. Article II - General Provisions February 6, 2002 -38-

(4) ADP Test Safe Harbor. (A) ADP Test Safe Harbor Contributions. (i) Unless the Employer elects in the Adoption Agreement to make Enhanced Matching Contributions or Safe Harbor Nonelective Contributions, the Employer shall contribute for the Contribution Period a Safe Harbor Matching Contribution equal to: (a) $1.00 for each $1.00 of any Employee's Elective Deferral Contributions up to three (3) percent of the Employee's Compensation for the Contribution Period; plus (b) $.50 for each $1.00 of the Employee's Elective Deferral Contribution in excess of three (3) percent of the Employee's Compensation but that do not exceed five (5) percent of the Employee's Compensation. The ADP Test Safe Harbor Contribution in this section 2.C.1(l)(4)(A) shall be known as Basic Matching Contributions. (ii) Notwithstanding the requirements of (i) above that the Employer make the ADP Test Safe Harbor Contribution to this Plan, if the Plan is a non-standardized plan and the Employer elects in the Adoption Agreement, the ADP Test Safe Harbor Contribution will be made to the defined contribution plan of the Employer indicated in the Adoption Agreement. However, the ADP Test Safe Harbor Contribution must be made to this Plan unless (a) each Employee eligible under this Plan is also eligible under the other plan, and (b) the other Plan has the same Plan Year as this Plan. (iii) ADP Test Safe Harbor Contributions are nonforfeitable and may not be distributed earlier than separation from service, death, disability, an event described in Code section 401(k)(10), or, in the case of a profit sharing plan, attainment of age 59-1/2. In addition, such contributions must satisfy the ADP Test Safe Harbor without regard to permitted disparity under Code section 414(l). Article II - General Provisions February 6, 2002 -39-

(B) Notice Requirement. At least 30 days, but not more than 90 days, before the beginning of each Plan Year, the Employer shall provide each Eligible Employee a comprehensive notice of the Employee's rights and obligations under the Plan, written in a manner calculated to be understood by the average Eligible Employee. If the Employee become eligible after the 90th day before the beginning of the Plan Year (including any Employee who become eligible during the Plan Year), and does not receive the notice for that reason, the notice must be provided no more than 90 days before the Employee becomes eligible but not later than the date the Employee become eligible. (C) Election Periods. In addition to any other election periods provided under the Plan, each Eligible Employee may make or modify a deferral election during the 30-day period immediately following receipt of the notice described in (B) above. (5) ACP Test Safe Harbor. ACP Test Safe Harbor Matching Contributions. (A) In addition to the ADP Safe Harbor Matching Contributions described in section 2.C.1(l)(4) above, the Employer will make the ACP Test Safe Harbor Contributions, if any, indicated in the Adoption Agreement for the Contribution Period. (B) ACP Test Safe Harbor Contributions will be vested as indicated in the Adoption Agreement, but, in any event, such contributions shall be 100% vested at Normal Retirement Age, upon the complete or partial termination of the Plan, or upon the complete discontinuance of Employer Contributions. (C) Forfeitures of any nonvested ACP Test Safe Harbor Contributions shall be applied in the manner elected by the Employer in the Adoption Agreement. (6) Other Requirements. All contributions made to a Safe Harbor 401(k) Plan shall not be based on Considered Net Profits of the Employer. (m) Suspension of Contributions. (1) Elective Deferral Contributions. The following provisions shall apply with respect to suspension of Elective Deferral Contributions, including Elective Article II - General Provisions February 6, 2002 -40-

Deferral Contributions made under a Safe Harbor 401(k) Plan. (A) Voluntary Suspension. A Participant may elect to suspend his Salary Deferral Agreement for Elective Deferral Contributions by filing a written notice thereof with the Plan Administrator. Such Contributions shall be suspended on the date specified in such notice, which date must be at least 15 days after such notice is filed. The notice shall specify the period for which such suspension shall be effective. (B) Suspension for Leave. A Participant who is absent from employment on account of an authorized unpaid leave of absence, military leave, or for a period of qualified military service, shall have his Salary Deferral Agreement suspended during such leave. Such suspension of contributions shall be effective on the date payment of Compensation by the Employer to him ceases, and shall remain in effect until payment of Compensation resumes. (C) Withdrawal Suspension. A Participant who elects a withdrawal in accordance with Section 3E may have his Elective Deferral Contributions suspended on the date such election becomes effective. Such suspension shall remain in effect for the number of months specified therein. If a Participant receives a serious financial hardship withdrawal of Elective Deferral Contributions, all employee contributions (both pre-tax and post-tax contributions) will be suspended in accordance with section 3E.8 of the Plan. (D) Non-Elective Suspension. A Participant who ceases to meet the eligibility requirements as specified in Section 2B.1 but who remains in the employ of the Employer shall have his Elective Deferral Contributions suspended, effective as of the date he ceases to meet the eligibility requirements. Such suspension shall remain in effect until he again meets such eligibility requirements. The Participant may elect to reactivate his Salary Deferral Agreement for Elective Deferral Contributions by filing a written notice thereof with the Plan Administrator. The Salary Deferral Agreement shall be reactivated following the expiration of the suspension period described above. (2) Required Employee Contributions. The following provisions shall apply with respect to suspension of Required Employee Contributions by Participants. In the event that a Participant suspends his Required Employee Contributions, he Article II - General Provisions February 6, 2002 -41-

shall automatically have his Voluntary Employee Contributions suspended for the same period of time. (A) Voluntary Suspension. A Participant may elect to suspend his payroll deduction authorization for his Required Employee Contributions by filing a written notice thereof with the Plan Administrator. Such notice shall be effective, and his applicable contributions shall be suspended, on the date specified in such notice, which date must be at least 15 days after such notice is filed. The notice shall specify the period for which such suspension shall be effective. Such period must be a minimum of one month and may extend indefinitely. (B) Suspension for Leave. A Participant who is absent from employment on account of an authorized unpaid leave of absence, military leave, or for a period of qualified military leave, shall have his payroll deduction authorization for Required Employee Contributions suspended during such leave. Such suspension of contributions shall be effective on the date payment of Compensation by the Employer to him ceases, and shall remain in effect until payment of Compensation resumes. (C) Withdrawal Suspension. A Participant who elects a withdrawal in accordance with Section 3E may have his Required Employee Contributions suspended on the date such election becomes effective. Such suspension shall remain in effect for the number of months specified under the provisions of Section 3E. If a Participant receives a serious financial hardship withdrawal of Elective Deferral Contributions, all employee contributions (both pre-tax and post-tax contributions) will be suspended in accordance with section 3E.8 of the Plan. (D) Involuntary Suspension. A Participant who ceases to meet the eligibility requirements as specified in Section 2B.1 but who remains in the employ of the Employer shall have his Required Employee Contributions suspended, effective as of the date he ceases to meet the eligibility requirements. Such suspension shall remain in effect until he again meets such eligibility requirements. The Participant may elect to reactivate his payroll deduction authorization by filing a written notice thereof with the Plan Administrator. The payroll deduction authorization shall be reactivated following the expiration of the suspension period described above. (3) Voluntary Employee Contributions. The following provisions apply with respect to suspension of Voluntary Employee Contributions by Participants. Article II - General Provisions February 6, 2002 -42-

(A) Voluntary Suspension. A Participant may elect to suspend his payroll deduction authorization for his Voluntary Employee Contributions by filing a written notice thereof with the Plan Administrator. Such notice shall be effective, and his applicable contributions shall be suspended, on the date specified in such notice, which date must be at least 15 days after such notice is filed. The notice shall specify the period for which such suspension shall be effective. (B) Suspension for Leave. A Participant who is absent from employment on account of an authorized unpaid leave of absence, military leave, or for a period of qualified military leave, shall have his payroll deduction order for Voluntary Employee Contributions suspended during such leave. Such suspension of contributions shall be effective on the date payment of Compensation by the Employer to him ceases, and shall remain in effect until payment of Compensation resumes. (C) Withdrawal Suspension. A Participant who elects a withdrawal in accordance with Section 3E may have his Voluntary Employee Contributions suspended on the date such election becomes effective. Such suspension shall remain in effect for the number of months specified therein. If a Participant receives a serious financial hardship withdrawal of Elective Deferral Contributions, all employee contributions (both pre-tax and post-tax contributions) will be suspended in accordance with section 3E.8 of the Plan. (D) Involuntary Suspension. A Participant who ceases to meet the eligibility requirements as specified in Section 2B.1 but who remains in the employ of the Employer shall have his Voluntary Employee Contributions suspended, effective as of the date he ceases to meet the eligibility requirements. Such suspension shall remain in effect until he again meets such eligibility requirements. The Participant may elect to reactivate his payroll deduction authorization by filing a written notice thereof with the Plan Administrator. The payroll deduction authorization shall be reactivated following the expiration of the suspension period described above. 2C.2 MONEY PURCHASE PENSION PLAN. (a) Contributions - Employer. As specified in the Adoption Agreement, the Employer shall contribute an amount equal to a fixed percentage of each Participant's Compensation, a flat dollar amount, or an amount integrated with Social Security in accordance with (1), (2) or (3) below: Article II - General Provisions February 6, 2002 -43-

(1) Formula A: Not Integrated with Social Security. An amount equal to a percentage from l% to 25% of the Compensation of each Participant, as elected by the Employer in the Adoption Agreement, subject to the Limitations on Allocations in accordance with Section 4B. (2) Formula B: Flat Dollar Amount. An amount, as elected by the Employer in the Adoption Agreement. (3) Formula C: Integrated with Social Security. Base Contribution: An amount equal to a percentage (as specified in the Adoption Agreement) of Compensation of each Participant up to the Social Security Integration Level; Excess Contribution: In addition, an amount equal to a percentage (as specified in the Adoption Agreement) of the Participant's Compensation which is in excess of the Social Security Integration Level, subject to the Limitations on Allocations in accordance with Section 4B. This Excess Contribution percentage shall not exceed the lesser of: (A) twice the Base Contribution or (B) the Base Contribution plus the greater of: (i) old age insurance portion of the Old Age Survivor Disability (OASDI) tax rate; or (ii) 5.7%. If the Employer has elected in the Adoption Agreement to use a Social Security Integration Level that in any Plan Year is the greater of $10,000 or 20% but less than 100% of the Social Security Taxable Wage Base, then the 5.7% limitation specified in 2C.2(a)(3)(B)(ii) shall be adjusted in accordance with the following table: IF THE SOCIAL SECURITY INTEGRATION LEVEL is more but not more Adjust than than 5.7% to - ------------------------------------------------------------------------ the greater of $10,000 or 80% of the Social Security 4.3% 20% of the Social Security Taxable Wage Base Taxable Wage Base 80% of the Social Security 100% of the Social Security 5.4% Taxable Wage Base Taxable Wage Base Article II - General Provisions February 6, 2002 -44-

However, in the case of any Participant who has exceeded the Cumulative Permitted Disparity Limit described below, the Employer will contribute for each Participant who either completes more than 500 Hours of Service during the Plan Year or is employed on the last day of the Plan Year, an amount equal to the Excess Contribution percentage multiplied by the Participant's total Compensation. Annual Overall Permitted Disparity Limit. Notwithstanding the preceding provisions of this Section 2C.2(a), for any Plan Year this Plan benefits any Participant who benefits under another qualified plan or simplified employee pension plan, as defined in Code section 408(k), maintained by the Employer that provides for permitted disparity (or imputes disparity), Employer contributions and Forfeitures will be allocated to the account of each Participant who either completes more than 500 Hours of Service during the Plan Year or who is employed as of the last day of the Plan Year in the ratio that such Participant's total Compensation bears to the total Compensation of all Participants. Cumulative Permitted Disparity Limit. Effective for Plan Years beginning on or after January 1, 1995, the Cumulative Permitted Disparity Limit for a Participant is 35 total cumulative permitted disparity years. Total cumulative permitted years mean the number of years credited to the Participant for allocation or accrual purposes under this Plan, any other qualified plan or simplified employee pension plan (whether or not terminated) ever maintained by the Employer. For purposes of determining the Participant's Cumulative Permitted Disparity Limit, all years ending in the same calendar year are treated as the same year. If the Participant has not benefited under a defined benefit or target benefit plan for any year beginning on or after January 1, 1994, the Participant has no Cumulative Permitted Disparity Limit. (b) Contributions - Participant. The Plan Administrator will not accept Required Employee Contributions or Voluntary Employee Contributions that are made for Plan Years beginning after the Plan Year in which this document is being adopted by the Employer. Required Employee Contributions and Voluntary Employee Contributions for Plan Years beginning after December 31, 1986, but before the Plan Year in which this document is adopted, will be limited so as to meet the nondiscrimination test of Code section 401(m) as provided in Section 4A.4. (c) Contributions - Timing. Contributions made on other than an annual basis shall be paid to the Trust or Insurance Company, as applicable, not less frequently than monthly or every four weeks. Contributions made on an annual basis shall be paid to the Trust or the Insurance Company, as applicable, at the end of the Plan Year, or as soon as possible on or after the last Article II - General Provisions February 6, 2002 -45-

day of such Plan Year, but in any event not later than the date prescribed by law for filing the Employer's income tax return, including any extension thereof. To the extent that contributions are used to purchase Life Insurance Policies, such contributions for any Plan Year may be paid to the Trust when premiums for such Policies are due during the Plan Year. (d) Contributions - Allocation. Employer Contributions shall be allocated to the Participants' Account in accordance with the allocation requirements as specified by the Employer in the Adoption Agreement. If the Employer has adopted a standardized plan, the allocation of any nonannual contribution made by the Employer shall be made for each Participant who is a Participant on any day of the Contribution Period regardless of Hours of Service. (e) Forfeitures. Forfeitures will be used in the manner elected in the Adoption Agreement as follows: (1) Allocated in the same manner elected in the Adoption Agreement for the allocation of Employer contributions; or (2) First, to reduce Employer contributions or pay Plan expenses, with any remaining Forfeitures allocated in the same manner elected in the Adoption Agreement for the allocation of Employer contributions. (f) Expenses. The Employer may contribute to the Plan the amount necessary to pay any applicable expense charges and administration charges. In lieu of the Employer contributing the amount necessary to pay such charges, these expenses may be paid from Plan assets. Article II - General Provisions February 6, 2002 -46-

2C.3 ROLLOVER CONTRIBUTIONS. If elected by the Employer in the Adoption Agreement, and without regard to the limitations imposed under Section 4B, the Plan may receive Rollover Contributions on behalf of an Employee, if the Employee is so entitled under Code sections 402(c), 403(a)(4), or 408(d)(3)(A). Contributions may be rolled over into the Plan either directly or indirectly, in the form of cash, and, if elected by the Employer in the Adoption Agreement, in the form of a loan note from a prior Code section 401(a) qualified plan in which the employee was a participant, and may be all or a portion of the funds eligible for rollover. Receipt of Rollover Contributions shall be subject to the approval of the Plan Administrator. Before approving the receipt of a Rollover Contribution, the Plan Administrator may request any documents or other information from an Employee or opinions of counsel which the Plan Administrator deems necessary to establish that such amount is a Rollover Contribution. If Rollover Contributions are elected by the Employer in the Adoption Agreement, they may, if also elected by the Employer in the Adoption Agreement, be received from an Employee who is not otherwise eligible to participate in the Plan. Rollover Contributions may be withdrawn by such Employee pursuant to the provisions of the Adoption Agreement and Section 3E. In addition, such Employee may direct the investment and transfer of amounts in his Participant's Account pursuant to the terms of Section 5A. Upon Termination of Employment, such Employee shall be entitled to a distribution of his Participant's Account. 2C.4 PARTICIPANT INITIATED TRANSFERS. For plan amendments adopted and effective on or after September 6, 2000, and if elected by the Employer in the Adoption Agreement, a Participant may elect to transfer amounts directly from a qualified plan to this qualified plan, or vice versa, provided the following requirements are met. (a) Elective Transfers. (1) The Participant must be eligible for an immediate distribution of benefits from the transferor plan. (2) The Participant must voluntarily elect, with spousal consent, if necessary, to transfer the benefits. Such a transfer will eliminate all protected forms of benefits that were available under the transferor plan. The Participant must have the option of leaving the benefits in the transferor plan, or to take an optional form of benefit if the transferor plan is terminating. (3) The Participant's transferred benefit must be 100% vested. (4) The amount transferred, plus the amount of any allowable simultaneous direct rollover, must equal 100% of the Participant's vested benefit. Article II - General Provisions February 6, 2002 -47-

(5) On or after January 1, 2002, the transfer occurs only when the Participant is not eligible to receive an immediate distribution of his or her entire nonforfeitable benefit in a single sum distribution consisting entirely of a distribution eligible for a direct rollover. In such an instance, the amount transferred may consist of either the benefit that may not be directly rolled over or the entire benefit. In either case, the entire amount is treated as an elective transfer. (b) Transaction Transfers. (1) The transaction must be made in connection with an asset acquisition, stock acquisition, merger, or other similar transaction, involving a change in the employer of the employees of a trade or business. (2) The transfer may be made only between like-kind defined contribution plans [e.g., section 401(k) plan to section 401(k) plan, money purchase pension plan to money purchase pension plan], except that a transfer from a non-section 401(k) profit sharing plan or a non-employee stock ownership plan (ESOP) stock bonus plan may be made to any type of defined contribution plan. (3) The Plan receiving the transferred benefits must provide Qualified Joint and Survivor Annuity and Qualified Preretirement Survivor Annuity benefits on the transferred assets if those rules applied to the assets while in the transferor plan. (4) The rules of Code section 411(a)(10) and Section 7B.1, applicable to a plan amending its vesting schedule, shall apply to the transferred benefits. (c) Employment Change Transfers. (1) The transfer is made in connection with a change in the Participant's employment status such that the Participant would not be entitled to additional allocations under the transferor plan. (2) All requirements of subparagraph (b), above, apply. 2C.5 CONTRIBUTIONS UNDER THE PLAN SUBJECT TO DAVIS-BACON ACT. If the Employer designates under the Adoption Agreement that Employer contributions under the Plan are to be made in different amounts for different contracts subject to the Davis-Bacon Act or other Prevailing Wage Law, the Employer shall file with the Plan Administrator an irrevocable written designation for each Prevailing Wage Law project, stating the hourly contribution rate to be contributed to the Plan by the Employer for each class of Employees working on the project in order to comply with the Article II - General Provisions February 6, 2002 -48-

Prevailing Wage Law applicable to the project. The contribution rate designation shall be irrevocable with respect to work on that project, although the hourly contribution rate may be increased prospectively by the filing of a new written contribution rate designation with the Plan Administrator. 2C.6 QVEC CONTRIBUTIONS. The Plan Administrator will not accept QVEC Contributions which are made for a taxable year beginning after December 31, 1986. Contributions made prior to that date will be maintained in a separate account that will be nonforfeitable at all times. The account will share in the gains and losses under the Plan in the same manner as described in Section 5A.3 of the Plan. No part of the QVEC Contributions portion of the Participant's Account will be used to purchase Life Insurance Policies. No part of the QVEC Contributions portion of the Participant's Account will be available for loans. Subject to Section 3C, Joint and Survivor Annuity Requirements (if applicable), the Participant may withdraw any part of his QVEC Contributions by making a written application to the Plan Administrator. Article II - General Provisions February 6, 2002 -49-

ARTICLE III - DISTRIBUTIONS 3A. TIMING AND FORM OF BENEFITS 3A.1 PAYMENT OF BENEFITS. The rules and procedures for electing the timing and form of distribution effective for each Participant or Beneficiary shall be formulated and administered by the Plan Administrator in a consistent manner for all Participants in similar circumstances. For money purchase and target benefit plans, the normal form of distribution shall be a Life Annuity. For a profit sharing plan, the normal form of distribution shall be a single sum cash payment. For any plan, the distribution shall be made within an administratively reasonable time following the date the application for distribution is filed with the Plan Administrator. If elected by the Employer in the Adoption Agreement, a Participant, or his Beneficiary as the case may be, may elect to receive distribution of all or a portion of his Vested Interest in one or a combination of the following forms of payment: (a) Single sum cash payment; (b) Life Annuity; (c) Installment Payments (i.e., a series of periodic single-sum cash payments over time, with no life contingency); (d) Installment Refund Annuity (i.e., an Annuity that provides for fixed monthly payments for a period certain of not less than 3 nor more than 15 years. If a Participant dies before the period certain expires, the Annuity will be paid to the Participant's Beneficiary for the remainder of the period certain. The period certain shall be chosen by the Participant at the time the Annuity is purchased with the Participant's Vested Interest. The Installment Refund Annuity is not a Life Annuity and in no event shall the period certain extend to a period which equals or exceeds the life expectancy of the Participant); (e) Employer stock, to the extent the Participant is invested therein. (f) In-kind distribution from self-directed brokerage account, to the extent the Participant is invested therein. The election of the form of distribution shall be irrevocable. If elected by the Employer in the Adoption Agreement, upon termination of the Plan, all distributions shall be made in a single lump sum distribution. All distributions are subject to the provisions of Section 3C, Joint and Survivor Annuity Requirements. Article III - Distributions February 6, 2002 -50-

For plan amendments adopted and effective on or after September 6, 2000, the Employer may amend the Plan to eliminate or restrict the ability of Participants to receive a distribution under any form, or combination of forms, benefit, provided that thereafter the forms of benefit available to the Participant include the right to take a single sum cash payment form of distribution under the same conditions as to timing and eligibility as the form of benefit eliminated or restricted. Any amendment under the provisions of the preceding sentence shall not apply to any participant with an Annuity Starting Date that precedes the earlier of (a) the 90th day after the date such Participant receives a summary of material modification reflecting the change, or (b) the first day of the second year beginning after the date the amendment is adopted. However, a Qualified Joint and Survivor Annuity form of payment may not be removed from a money purchase pension plan, or from that portion of a profit sharing plan, including a section 401(k) plan, that maintains assets transferred to it from a plan that was subject to the Qualified Joint and Survivor Annuity requirements. In addition, any amendment eliminating the ability of a Participant to receive a distribution in the form of Employer Stock may only be made with respect to amounts not already invested in Employer Stock as of the date of amendment or some future date. The employer shall maintain a list of those Participants who are eligible for a distribution of Employer Stock. If the value of a Participant's Vested Interest is $5,000 or such lesser amount as indicated by the Employer in the Adoption Agreement, the Employer shall indicate in the Adoption Agreement whether a distribution shall be made in the form of a single sum cash payment upon such Participant's Termination of Employment and may not be deferred or the Participant may elect to defer distribution until the Employee's Required Beginning Date. If the Employer permits Participants to defer such distributions, failure to make an election will be deemed to be an election to defer to the Employee's Required Beginning Date. If the Participant's Vested Interest exceeds $5,000 or such lesser amount as indicated by the Employer on the Adoption Agreement, and such amount is immediately distributable, the Participant and the Participant's Spouse, if required, (or where the either the Participant or the Spouse has died, the survivor) must consent to any distribution of such account balance. The consent of the Participant and the Participant's Spouse, if required, shall be obtained in writing within the 90-day period ending on the Annuity Starting Date. The "Annuity Starting Date" is the first day of the first period for which an amount is paid as an Annuity or any other form. An account balance is considered immediately distributable if any part of the account balance could be distributed to the Participant (or surviving Spouse) before the Participant attains (or would have attained if not deceased) the later of Normal Retirement Age or age 62. Article III - Distributions February 6, 2002 -51-

Instead of consenting to a distribution, the Participant may elect to defer the distribution until his or her Required Beginning Date. Failure to make an election will be deemed to be an election to defer to the Required Beginning Date. Notwithstanding any prior provision, if a former Participant maintains an account balance in the Plan subsequent to termination, the Employer may mandate a distribution in the form of an immediate single sum cash pay-out if the value of such account ceases to exceed $5,000 or such lesser amount as indicated by the Employer in the Adoption Agreement. The preceding sentence shall not apply to any annuity or installment payments for which one or more scheduled periodic payments remain. The Plan Administrator shall notify the Participant and the Participant's Spouse of the right to defer any distribution. Such notification shall include a general description of the material features and an explanation of the relative values of the optional forms of benefit available under the Plan in a manner that would satisfy the notice requirements of Code section 417(a)(3), and shall be provided no less than 30 days and no more than 90 days prior to the Annuity Starting Date. If the distribution is one to which Code sections 401(a)(11) and 417 do not apply, such distribution may commence less than 30 days after the notice required under Code regulation section 1.411(a)-11(c) is given, provided that: (a) The Plan Administrator clearly informs the Participant that the Participant has a right to a period of at least 30 days after receiving the notice to consider the decision of whether or not to elect a distribution (and, if applicable, a particular distribution option); (b) The Participant, after receiving the notice, affirmatively elects a distribution; (c) The Participant may revoke any affirmative distribution election prior to the Annuity Starting Date, or, if later, at any time prior to the expiration of the 7-day period beginning the day after the explanation of the Qualified Joint and Survivor Annuity is provided to the Participant; and (d) The Annuity Starting Date is a Date after the date the written explanation is provided to the Participant. For distributions on or after December 31, 1996, the Annuity Starting Date may be a date prior to the date the written explanation is provided to the Participant, provide the distribution does not commence until at least 30 days after the written explanation is provided, and the other provisions of this paragraph are met. Notwithstanding the foregoing, only the Participant need consent to the commencement of a distribution in the form of a Qualified Joint and Survivor Annuity while the account balance is immediately distributable. Furthermore, if payment in the form of a Qualified Joint and Survivor Annuity is not required with respect to the Participant pursuant to Section 3C.6 of the Plan, Article III - Distributions February 6, 2002 -52-

only the Participant need consent to the distribution of an account balance that is immediately distributable. Neither the consent of the Participant nor the Participant's Spouse shall be required to the extent that a distribution is required to satisfy Code section 401(a)(9) or section 415. In addition, upon termination of this Plan, if the Plan does not offer an annuity option (purchased from a commercial provider) and if the Employer or any entity within the same controlled group as the Employer does not maintain another defined contribution plan (other than an employee stock ownership plan as defined in Code section 4975(e)(7)), the Participant's account balance will, without the Participant's consent, be distributed to the Participant. However, if any entity within the same controlled group as the Employer maintains another defined contribution plan (other than an employee stock ownership plan as defined in Code section 4975(e)(7), then the Participant's account balance will be transferred without the Participant's consent to the other plan if the Participant does not consent to an immediate distribution. For purposes of determining the applicability of the foregoing consent requirements to distributions made before the first day of the first Plan Year beginning after December 31, 1988, the Participant's vested account balance shall not include amounts attributable to QVEC Contributions made between December 31, 1981 and January 1, 1987, plus gains and minus losses thereon ("accumulated QVEC Contributions"). The terms of any annuity contract purchased and distributed by the Plan to a Participant or Spouse shall comply with the requirements of this Plan. A Participant who terminates employment and does not consent to an immediate distribution shall have his distribution deferred. Such a distribution shall commence no later than his Required Beginning Date. Loans may not be initiated for Participants covered by this paragraph except if, after his Termination of Employment, the Participant is still a party-in-interest (as defined in ERISA). A Participant who continues to maintain an account balance under the Plan may elect to withdraw an amount which is equal to any whole percentage (not to exceed 100%) from his Participant's Account. Such an election shall be made in accordance with Section 3E. Such Participant as described herein shall have the authority to direct the transfer of his Vested Interest in accordance with Section 5A.2. The election to defer distribution may be revoked at any time by submitting a written request to the Plan Administrator. Any Forfeiture attributable to withdrawals shall be subject to the requirements of Sections 3D.1 and 3E.8 of the Plan. A Participant whose Termination of Employment is on or after his Early Retirement Date may elect to defer the distribution subject to the requirements of Section 3B. 3A.2 COMMENCEMENT OF BENEFITS. Unless the Participant elects otherwise, distribution of benefits will begin no later than the 60th day after the latest of the close of the Plan Year in which: (a) The Participant attains age 65 (or Normal Retirement Age, if earlier); Article III - Distributions February 6, 2002 -53-

(b) The 10th anniversary of the year in which the Participant commenced participation in the Plan occurs; or, (c) The Participant terminates Service with the Employer. Notwithstanding the foregoing, the failure of a Participant and Spouse to consent to a distribution, if required, while a benefit is immediately distributable within the meaning of Section 3A.1 of the Plan, shall be deemed to be an election to defer distribution to the Participant's Required Beginning Date. However, in no event shall distribution of that portion of a Participant's Account attributable to Elective Deferral Contributions, Qualified Matching Contributions, and Qualified Nonelective Contributions be made prior to the earliest of the Participant's Retirement, death, Disability, separation from Service, attainment of age 59-1/2, or, with respect to Elective Deferral Contributions only, due to Serious Financial Hardship, unless such distribution is made on account of: (a) The Employer's sale, to an unrelated entity, of its interest in a subsidiary (within the meaning of Code section 409(d)(3)), where the Employer continues to maintain this Plan and the Participant continues employment with the subsidiary; or (b) The Employer's sale, to an unrelated corporation, of substantially all assets (within the meaning of Code section 409(d)(2)) used in its trade or business, where the Employer continues to maintain this Plan and the Participant continues employment with the employer acquiring such assets; or (c) The termination of the Plan, as provided in Section 7B, without the establishment of another defined contribution plan, other than an employee stock ownership plan (as defined in Code sections 4975(e)(7), a simplified employee pension plan (as defined in Code section 408(k)), or a SIMPLE IRA plan (as described in Code section 408(p)). All distributions that may be made in accordance with one or more of the preceding distributable events are subject to the spousal and Participant consent requirements (if applicable) of Code sections 401(a)(11) and 417. In addition, distributions made after March 31, 1988, which are triggered by any of the events described in the immediately preceding paragraphs (a), (b), or (c), must be made in a lump sum. 3A.3 FROM LIFE INSURANCE POLICIES. The Trustee shall arrange with the Insurance Company any distribution due to any Participant during his lifetime from any Life Insurance Policy or Policies on his life. The manner of distribution shall be a transfer of the values of said Policy or Policies to the Participant's Account for distribution as a portion thereof in accordance with this Section. Subject to Section 3C, Joint and Survivor Annuity Requirements, the Policies on a Participant's life will be converted to cash or Article III - Distributions February 6, 2002 -54-

an Annuity or distributed to the Participant upon commencement of benefits. In the event of any conflict between the terms of this Plan and the terms of any Life Insurance Policy purchased hereunder, the Plan provisions shall control. 3A.4 NONTRANSFERABLE. Any Annuity Contract distributed Hereford must be nontransferable. 3A.5 ALTERNATE PAYEE SPECIAL DISTRIBUTION. Distributions pursuant to Section 5D.8 may be made without regard to the age or employment status of the Participant. Article III - Distributions February 6, 2002 -55-

3B. MINIMUM DISTRIBUTION REQUIREMENTS 3B.1 DEFINITIONS. (a) APPLICABLE LIFE EXPECTANCY. The term Applicable Life Expectancy means the Life Expectancy (or joint and last survivor expectancy) calculated using the attained age of the Participant (or Designated Beneficiary) as of the Participant's (or Designated Beneficiary's) birthday in the applicable calendar year reduced by one for each calendar year which has elapsed since the date Life Expectancy was first calculated. If Life Expectancy is being recalculated, the Applicable Life Expectancy shall be the Life Expectancy so recalculated. The applicable calendar year shall be the first Distribution Calendar Year, and if Life Expectancy is being recalculated, such succeeding calendar year. (b) DESIGNATED BENEFICIARY. The term Designated Beneficiary means the individual who is designated as the Beneficiary under the Plan in accordance with Code section 401(a)(9) and the regulations thereunder. If a Participant's Beneficiary, as determined in accordance with Section 1.9, is his estate, such Participant shall be treated as having no Designated Beneficiary. (c) DISTRIBUTION CALENDAR YEAR. The term Distribution Calendar Year means a calendar year for which a minimum distribution is required. For distributions beginning before the Participant's death, the first Distribution Calendar Year is the calendar year immediately preceding the calendar year which contains the Participant's Required Beginning Date. For distributions beginning after the Participant's death, the first Distribution Calendar Year is the calendar year in which distributions are required to begin pursuant to Section 3B.3 below. (d) 5-PERCENT OWNER. For purposes of this Section, the term 5-Percent Owner means a 5-percent owner as defined in Code section 416(i) (determined in accordance with section 416 but without regard to whether the Plan is Top-Heavy) at any time during the Plan Year ending with or within the calendar year in which such Employee attains age 70-1/2 or any later Plan Year. Once distributions have begun to a 5-Percent Owner under this section, they must continue to be distributed even if the Employee ceases to be a 5-Percent Owner. (e) LIFE EXPECTANCY. The term Life Expectancy means life expectancy and joint and last survivor expectancy as computed by use of the expected return multiples in Table V and VI of section 1.72-9 of the Income Tax Regulations. Unless otherwise elected by the Participant (or Spouse, in the case of distributions described in Section 3B.3(b)(2)) by the time distributions are required to begin, Life Expectancies shall be recalculated annually. Such election shall be irrevocable as to the Participant (or Spouse) and Article III - Distributions February 6, 2002 -56-

shall apply to all subsequent years. The Life Expectancy of a non-Spouse Beneficiary may not be recalculated. (f) PARTICIPANT'S BENEFIT. The term Participant's Benefit means: (1) The Participant's Vested Interest as of the last valuation date in the calendar year immediately preceding the Distribution Calendar Year ("Valuation Calendar Year") increased by the amount of any contributions or Forfeitures allocated to the Participant's Account as of dates in the Valuation Calendar Year after the valuation date and decreased by distributions made in the Valuation Calendar Year after the valuation date. (2) Exception for second Distribution Calendar Year. For purposes of paragraph (1) above, if any portion of the minimum distribution for the first Distribution Calendar Year is made in the second Distribution Calendar Year on or before the Required Beginning Date, the amount of the minimum distribution made in the second Distribution Calendar Year shall be treated as if it had been made in the immediately preceding Distribution Calendar Year. (g) REQUIRED BEGINNING DATE. As elected by the Employer in the Adoption Agreement, the term Required Beginning Date shall mean either: (1) The Required Beginning Date of a Participant is the first day of April of the calendar year following the calendar year in which the Participant attains age 70-1/2 (Pre-SBJPA RBD); or (2) The Required Beginning Date of a Participant is the later of the first day of April of the calendar year following the calendar year in which the Participant attains age 70-1/2 or retires, except that benefit distributions to a 5-Percent Owner must commence by the first day of April of the calendar year following the calendar year in which the Participant attains age 70-1/2 (SBJPA RBD). As elected by the Employer in the Adoption Agreement: (1) The Pre-SBJPA RBD may be removed and replaced entirely by the SBJPA RBD at any time elected by the Employer in the Adoption Agreement, provided the date is a date after December 31, 1996, or (2) The Pre-SBJPA RBD may be replaced for any calendar year, as elected by the Employer in the Adoption Agreement, provided the calendar year is a calendar year after 1998, or (3) The Pre-SBJPA RBD may be replaced for any calendar year, as elected by the Employer in the Adoption Agreement, provided the calendar year is a calendar year after 1998. However, non-5% Owners may make an irrevocable election to receive payments beginning the Article III - Distributions February 6, 2002 -57-

April 1 following the calendar year in which they attain age 70-1/2, or (4) The Pre-SBJPA RBD shall apply to all Employees, or (5) The Pre-SBJPA RBD shall apply to all Employees, except that non-5% Owners who reach age 70-1/2 in any calendar year after 1998 may defer their Required Beginning Date to their SBJPA RBD. 3B.2 DISTRIBUTION REQUIREMENTS. (a) Except as otherwise provided in Section 3C, Joint and Survivor Annuity Requirements, the requirements of this Section 3B shall apply to any distribution of a Participant's Accrued Benefit and will take precedence over any inconsistent provisions of this Plan. Unless otherwise specified, the provisions of this Section apply to calendar years beginning after December 31, 1984. (b) All distributions required under this Section 3B shall be determined and made in accordance with regulations under section 401(a)(9), including the minimum distribution incidental benefit requirement of regulations section 1.401(a)(9)-2. A Participant's entire Vested Interest must be distributed or begin to be distributed no later than the Participant's Required Beginning Date. (c) Limits on Distribution Periods. As of the first Distribution Calendar Year, distributions, if not made in a single sum, may only be made over one of the following periods (or a combination thereof): (1) The life of the Participant; (2) The life of the Participant and a Designated Beneficiary; (3) A period certain not extending beyond the Life Expectancy of the Participant; or (4) A period certain not extending beyond the joint and last survivor expectancy of the Participant and a Designated Beneficiary. (d) Determination of amount to be distributed each year. If the Participant's Vested Interest is to be distributed in other than a single sum, the following minimum distribution rules shall apply on or after the Required Beginning Date: (1) If the Participant's entire Vested Interest is to be distributed over (1) a period not extending beyond the Life Expectancy of the Participant or the joint life and last survivor expectancy of the Participant and the Participant's Designated Beneficiary or (2) a period not extending beyond the Life Expectancy of the Designated Beneficiary, the amount required to be Article III - Distributions February 6, 2002 -58-

distributed for each calendar year, beginning with distributions for the first Distribution Calendar Year, must at least equal the quotient obtained by dividing the Participant's benefit by the Applicable Life Expectancy. (2) For calendar years beginning before January 1, 1989, if the Participant's Spouse is not the Designated Beneficiary, the method of distribution selected must assure that at least 50% of the present value of the amount available for distribution is paid within the Life Expectancy of the Participant. (3) For calendar years beginning after December 31, 1988, the amount to be distributed each year, beginning with distributions for the first Distribution Calendar Year, shall not be less than the quotient obtained by dividing the Participant's benefit by the lesser of (1) the Applicable Life Expectancy or (2) if the Participant's Spouse is not the Designated Beneficiary, the applicable divisor determined from the table set forth in regulations section 1.401(a)(9)-2, Q&A-4. Distributions after the death of the Participant shall be distributed using the Applicable Life Expectancy in Section 3B.2(d)(1) above, as the relevant divisor without regard to regulations section 1.401(a)(9)-2. (4) The minimum distribution required for the Participant's first Distribution Calendar Year must be made on or before the Participant's Required Beginning Date. The minimum distribution for other calendar years, including the minimum distribution for the Distribution Calendar Year in which the Employee's Required Beginning Date occurs, must be made on or before December 31 of that Distribution Calendar Year. (e) Other Forms. If the Participant's benefit is distributed in the form of an Annuity purchased from an Insurance Company, distributions thereunder shall be made in accordance with the requirements of Code section 401(a)(9) and the regulations thereunder. 3B.3 DEATH DISTRIBUTION PROVISIONS. Upon the death of the Participant, the following distribution provisions shall take effect: (a) Distributions Beginning Before Death. If the Participant dies after distribution of his entire Vested Interest has begun, the remaining portion of such entire Vested Interest will continue to be distributed at least as rapidly as under the method of distribution being used prior to the Participant's death. (b) Distributions Beginning After Death. If the Participant dies before distribution of his entire Vested Interest begins, distribution of the Participant's entire Vested Interest shall be completed by December 31 of the calendar Article III - Distributions February 6, 2002 -59-

year containing the fifth anniversary of the Participant's death except to the extent that an election is made to receive distributions in accordance with (1) or (2) below: (1) If any portion of the Participant's entire Vested Interest is payable to a Designated Beneficiary, distributions may be made over the Life Expectancy of the Designated Beneficiary commencing on or before December 31 of the calendar year immediately following the calendar year in which the Participant died; (2) If the Designated Beneficiary is the Participant's surviving Spouse, the date distributions are required to begin in accordance with (1) above shall not be earlier than the later of (i) December 31 of the calendar year immediately following the calendar year in which the Participant died and (ii) December 31 of the calendar year in which the Participant would have attained age 70-1/2. If the Participant has not made an election pursuant to this Section 3B.3(b) by the time of his or her death, the Participant's Designated Beneficiary must elect the method of distribution no later than the earlier of (1) December 31 of the calendar year in which distributions would be required to begin under this Section, or (2) December 31 of the calendar year which contains the fifth anniversary of the Participant's date of death. If the Participant has no Designated Beneficiary, or if the Designated Beneficiary does not elect a method of distribution, distribution of the Participant's entire Vested Interest must be completed by December 31 of the calendar year containing the fifth anniversary of the Participant's death and will be paid in the form of a single sum cash payment. (c) For purposes of Section 3B.3(b) above, if the surviving Spouse dies after the Participant, but before payments to such Spouse begin, the provisions of this Section, with the exception of paragraph (b)(2) therein, shall be applied as if the surviving Spouse were the Participant. (d) For purposes of this Section, dist