1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001 [ ] 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 ZIXIT CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) TEXAS 75-2216818 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER) 2711 NORTH HASKELL AVENUE SUITE 2850, LB 36 DALLAS, TEXAS 75204-2911 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (214) 515-7300 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS) AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO --- --- INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE. CLASS OUTSTANDING AT APRIL 30, 2001 - -------------------------------------- ------------------------------ COMMON STOCK, PAR VALUE $.01 PER SHARE 17,040,663

2 INDEX PART I-FINANCIAL INFORMATION Page Number ------ ITEM 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets at March 31, 2001 and December 31, 2000 3 Condensed Consolidated Statements of Operations for the three months ended March 31, 2001 and 2000 and for the cumulative period from January 1, 1999 through March 31, 2001 4 Condensed Consolidated Statement of Stockholders' Equity and Comprehensive Net Loss for the three months ended March 31, 2001 5 Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2001 and 2000 and for the cumulative period from January 1, 1999 through March 31, 2001 6 Notes to Condensed Consolidated Financial Statements 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 9 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 15 PART II-OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 15 2

3 ZIXIT CORPORATION (A DEVELOPMENT STAGE COMPANY) CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except share data) (Unaudited) March 31, 2001 December 31, 2000 -------------- ----------------- ASSETS Current assets: Cash and cash equivalents $ 34,541 $ 13,347 Marketable securities 8,698 36,943 Other current assets 1,751 1,942 ------------ ------------ Total current assets 44,990 52,232 Investment in Maptuit Corporation, at cost 3,000 3,000 Property and equipment, net 17,231 19,400 Other noncurrent assets, net 3,689 4,045 ------------ ------------ $ 68,910 $ 78,677 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 2,237 $ 2,431 Liabilities related to discontinued operations 1,111 1,116 Deferred revenues 35 -- ------------ ------------ Total current liabilities 3,383 3,547 Commitments and contingencies Stockholders' equity: Preferred stock, $1 par value, 10,000,000 shares authorized; none outstanding -- -- Common stock, $.01 par value, 175,000,000 shares 193 193 authorized; 19,332,563 issued, 17,040,663 outstanding in 2001 and 19,327,563 issued, 17,035,663 outstanding in 2000 Additional capital 180,529 180,128 Unearned stock-based compensation (11,037) (14,615) Treasury stock, at cost (11,314) (11,314) Accumulated other comprehensive loss (189) (169) Accumulated deficit (net of deficit accumulated during the development stage of $96,795 at March 31, 2001 and $83,233 at December 31, 2000) (92,655) (79,093) ------------ ------------ Total stockholders' equity 65,527 75,130 ------------ ------------ $ 68,910 $ 78,677 ============ ============ See accompanying notes. 3

4 ZIXIT CORPORATION (A DEVELOPMENT STAGE COMPANY) CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) (Unaudited) Cumulative During Three Months Development Stage Ended March 31, (From January 1, 1999 ------------------------------ Through 2001 2000 March 31, 2001) ------------ ------------ ----------------------- Revenues $ 104 $ 96 $ 597 Research and development expenses (2,205) (2,211) (34,414) Operating costs and general corporate expenses (12,183) (9,595) (71,862) Investment income, net 674 574 6,135 ------------ ------------ ------------ Loss from continuing operations before income taxes (13,610) (11,136) (99,544) Income tax benefit -- -- 807 ------------ ------------ ------------ Loss from continuing operations (13,610) (11,136) (98,737) Discontinued operations 48 -- 1,942 ------------ ------------ ------------ Net loss $ (13,562) $ (11,136) $ (96,795) ============ ============ ============ Basic and diluted loss per common share: Continuing operations $ (0.80) $ (0.72) Discontinued operations -- -- ------------ ------------ Net loss $ (0.80) $ (0.72) ============ ============ Weighted average shares outstanding 17,040 15,436 ============ ============ See accompanying notes. 4

5 ZIXIT CORPORATION (A DEVELOPMENT STAGE COMPANY) CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE NET LOSS (In thousands, except share data) (Unaudited) Unearned stock- based Common Stock Additional compen- Shares Amount capital sation ---------- ---------- ---------- ---------- Balance, December 31, 2000 19,327,563 $ 193 $ 180,128 $ (14,615) Exercise of stock options for cash 5,000 -- 24 -- Unearned stock- based compensation for service providers -- -- 381 (381) Amortization of unearned stock- based compensation -- -- -- 3,959 Other -- -- (4) -- Comprehensive net loss: Net loss -- -- -- -- Unrealized loss on marketable securities -- -- -- -- Comprehensive net loss -- -- -- -- ---------- ---------- ---------- ---------- Balance, March 31, 2001 19,332,563 $ 193 $ 180,529 $ (11,037) ========== ========== ========== ========== Accumulated other Total Treasury comprehensive Accumulated stockholders' stock loss deficit equity ---------- ------------- ---------- ---------- Balance, December 31, 2000 $ (11,314) $ (169) $ (79,093) $ 75,130 Exercise of stock options for cash -- -- -- 24 Unearned stock- based compensation for service providers -- -- -- -- Amortization of unearned stock- based compensation -- -- -- 3,959 Other -- -- -- (4) Comprehensive net loss: Net loss -- -- (13,562) (13,562) Unrealized loss on marketable securities -- (20) -- (20) ---------- Comprehensive net loss -- -- -- (13,582) ---------- ---------- ---------- ---------- Balance, March 31, 2001 $ (11,314) $ (189) $ (92,655) $ 65,527 ========== ========== ========== ========== See accompanying notes. 5

6 ZIXIT CORPORATION (A DEVELOPMENT STAGE COMPANY) CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited) Cumulative During Three Months Development Stage Ended March 31 (From January 1, 1999 ------------------------------ Through 2001 2000 March 31, 2001) ------------ ------------ -------------- Cash flows from operating activities: Loss from continuing operations $ (13,610) $ (11,136) $ (98,737) Adjustments to reconcile loss from continuing operations to net cash used by operating activities: Depreciation and amortization 2,749 2,222 16,153 Stock-based compensation 3,959 4,274 28,074 Write-down of marketable securities -- -- 1,202 Other non-cash expenses 100 -- 231 Changes in assets and liabilities, excluding divestiture of businesses: Other assets 141 312 (1,403) Current liabilities 92 (242) 698 ------------ ------------ ------------ Net cash used by continuing operations (6,569) (4,570) (53,782) Net cash provided (used) by discontinued operations 43 105 (1,403) ------------ ------------ ------------ Net cash used by operating activities (6,526) (4,465) (55,185) Cash flows from investing activities: Purchases of property and equipment, net (525) (1,555) (31,315) Purchases of marketable securities (3,960) (2,933) (160,360) Sales and maturities of marketable securities 32,185 16,000 179,072 Investment in Maptuit Corporation -- -- (3,000) Purchase of Anacom Communications -- -- (2,500) Proceeds from sales of discontinued operations, net of cash sold -- 581 5,885 ------------ ------------ ------------ Net cash provided (used) by investing activities 27,700 12,093 (12,218) Cash flows from financing activities: Proceeds from private placement of common stock, net of issuance costs -- -- 43,784 Proceeds from exercise of stock options 24 1,911 3,887 ------------ ------------ ------------ Net cash provided by financing activities 24 1,911 47,671 Effect of exchange rate changes on cash and cash equivalents (4) (4) (19) ------------ ------------ ------------ Increase (decrease) in cash and cash equivalents 21,194 9,535 (19,751) Cash and cash equivalents, beginning of period 13,347 6,598 54,292 ------------ ------------ ------------ Cash and cash equivalents, end of period $ 34,541 $ 16,133 $ 34,541 ============ ============ ============ See accompanying notes. 6

7 ZIXIT CORPORATION (A DEVELOPMENT STAGE COMPANY) NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION The accompanying financial statements, which should be read in conjunction with the audited consolidated financial statements included in the Company's 2000 Annual Report to Shareholders on Form 10-K, are unaudited but have been prepared in the ordinary course of business for the purpose of providing information with respect to the interim periods. The Condensed Consolidated Balance Sheet at December 31, 2000 was derived from the audited Consolidated Balance Sheet at that date which is not presented herein. Management of the Company believes that all adjustments necessary for a fair presentation for such periods have been included and are of a normal recurring nature. The results of operations for the three-month period ended March 31, 2001 are not necessarily indicative of the results to be expected for the full year. During 1998, the Company sold all of its operating businesses and, accordingly, the assets and liabilities, operating results and cash flows of these businesses have been classified as discontinued operations in the accompanying financial statements. Since 1999, the Company has been developing a digital signature and encryption technology and is developing a series of products and services that enhance privacy, security and convenience over the Internet. ZixMail(TM) is a user friendly, secure document delivery service that enables Internet users worldwide to easily send and receive encrypted and digitally signed communications without changing their existing email systems or addresses. The Company did not begin to charge for the use of these products and services until the first quarter of 2001. Successful development of a development stage enterprise, particularly Internet related businesses, is costly and highly competitive. The Company's growth depends on the timely development and market acceptance of its products. A development stage enterprise involves risks and uncertainties, and there are no assurances that the Company will be successful in its efforts. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." The amounts presented for basic and diluted loss per common share in the accompanying statements of operations have been computed by dividing the applicable loss 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. 2. STOCKHOLDERS' EQUITY The Company recognizes significant non-cash stock-based compensation expense resulting from common stock issuable in connection with the purchase of Anacom Communications, Inc. ("Anacom") and from certain stock option grants made to third party service providers, employees and directors. Unearned stock-based compensation expense of $9,715,000 as of March 31, 2001 related to certain of these equity securities is fixed in amount and will be amortized to expense primarily in 2001. The determination of the amount to be expensed for the remaining equity securities requires that they be revalued on each reporting date until performance is complete with a cumulative catch up adjustment recognized for any changes in their fair value. The Company's future results of operations could be materially impacted by a change in valuation of these variable equity securities as a result of future increases or decreases in the price of the Company's common stock. 3. COMMITMENTS 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 ZixMail.net messaging portal. The Company has minimum future commitments to Yahoo! under this agreement totalling 7

8 $5,025,000, payable in quarterly installments through August 2002. In addition, the Company will pay Yahoo! a specified portion of revenues earned by the Company which are associated with Yahoo! users. 4. LITIGATION On December 30, 1999, the Company and ZixCharge.com, Inc. ("ZixCharge"), a wholly-owned subsidiary of the Company, filed a lawsuit against Visa U.S.A., Inc. and Visa International Service Association (collectively "Visa") in the 192nd Judicial District Court of Dallas County, Texas. To obtain large numbers of consumers and merchants as users of its ZixCharge system, the Company's initial marketing efforts were focused on obtaining financial institutions as sponsors of the ZixCharge system. The suit alleges that Visa undertook a series of actions that interfered with these prospective business relationships and disparaged the Company, its products, its management and its stockholders. The suit alleges that Visa intentionally set out to destroy the Company's ability to market its ZixCharge system, which competed against the MasterCard and Visa-owned Secure Electronic Transaction system. The suit, which is in the discovery phase, seeks monetary damages and such other relief as the court deems appropriate. The Company believes it is unlikely that any Visa member banks will enter into any ZixCharge sponsorship agreements until the Visa litigation is resolved. Moreover, the resolution of the lawsuit could have a material effect on the Company's ability to market the ZixCharge system. 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 affect on the Company's consolidated financial statements. 8

9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Historically, the Company operated in one industry segment, the provision of systems and solutions for the intelligent transportation, electronic security and other markets. The Company's operations included the design, manufacturing, installation and support of hardware and software products utilizing the Company's wireless data and security technologies. The businesses comprising this industry segment were sold during 1998 and 1997 and have been classified as discontinued operations in the condensed consolidated financial statements. Since January 1999, the Company has been developing a digital signature and encryption technology and is developing a series of products and services that enhance privacy, security and convenience over the Internet. The Company did not begin to charge for the use of these products and services until the first quarter of 2001. ZixMail(TM) is a user friendly, secure document delivery service that enables Internet users worldwide to easily send and receive encrypted and digitally signed communications without changing their existing email systems or addresses. The foundation of the Company's business model for its ZixMail services centers around the financial leverage expected to be generated by revenues that are believed to be predominantly recurring in nature and an efficient cost structure for data center operations, the core of which is expected to remain relatively stable regardless of the number of users. New business, primarily focused on the corporate market, is expected to be generated from the Company's own direct sales efforts, its affiliate marketing programs and the promotional efforts of its strategic marketing partners. Revenue streams in the near term are projected to consist primarily of ZixMail subscription fees, which are list priced at $24.00 per year per email address and generally expected to be collected annually at the beginning of the subscription period. In the first quarter of 2001, the Company began charging for its ZixMail services and, during 2001, expects to expand its sales and marketing reach and to incur certain variable customer acquisition costs associated with generating subscription fees. These variable costs include revenue sharing arrangements with the Company's strategic marketing partners, anticipated to average between 20 to 25 percent of first-year subscription fees, and performance-based incentive compensation earned by the Company's direct sales staff. The Company has set a goal of obtaining 600,000 ZixMail subscribers by the end of 2001, starting from a base of several thousand users generally reflecting the Company's previous marketing approach, which was heavily weighted toward the consumer market. Based upon its anticipated cost structure, the Company currently estimates that it can become cash flow positive from operations in any period in which it receives annual subscription fees from an average of 150,000 or more new subscribers per month. The Company believes that it is possible to attain such levels of order activity sometime in the first half of 2002. Thereafter, if a base of 1,800,000 subscribers is attained, the Company expects to achieve the financial leverage generated by recurring revenues and a relatively stable cost structure, which is expected to result in a favorable cash flow scenario as new subscribers are added. For financial accounting purposes, subscription fees will be recognized as revenue on a prorated basis over the length of the subscription period, usually one year. As a result of the spreading of revenues over the applicable service period, a large portion of the new business added in 2001 will not be recognized as revenue in 2001; however, the deferred revenues generated should provide the Company with additional cash and a predictable base of revenue leading into 2002. When coupled with the Company's current cash expenditure levels, and the significant levels of non-cash expenses which are expected to exceed $20,000,000, this method of recognizing revenue makes it likely that the Company will incur a substantial net loss in 2001. However, as was the case in 2000, the anticipated reduction in the Company's cash resources in 2001 will be substantially less than the expected net loss. Additionally, in October 1999, the Company purchased all of the outstanding shares of Anacom, a privately-held provider of real-time transaction processing services to Internet merchants. 9

10 RESULTS OF OPERATIONS CONTINUING OPERATIONS Revenues The Company is in the development stage and had no significant revenues in 2000 and 2001. The Company began charging for its ZixMail products and services in the first quarter of 2001. Subscription fees billed or received from customers in advance are recorded as deferred revenue and recognized as revenues ratably over the subscription period. Research and development expenses Research and development expenses were virtually unchanged from $2,211,000 in the first quarter of 2000 to $2,205,000 for the corresponding period in 2001. In 2001, employee compensation costs increased over the comparable period in 2000 and were offset by a reduction in third party consulting expenditures as a result of hiring additional technical personnel to support the development of the Company's various Internet products. Operating costs and general corporate expenses Operating costs and general corporate expenses increased from $9,595,000 in the first quarter of 2000 to $12,183,000 for the same period in 2001. The increase is primarily due to additional costs incurred for sales and marketing of the ZixMail products and services, including strategic marketing expenses with Yahoo! and the hiring of additional personnel in the areas of direct sales and marketing support. Also, depreciation expense is higher in 2001 due to an increased investment in property and equipment. In the near-term, the Company plans to continue the expansion of its sales and marketing effort. Additionally, new categories of costs will begin to be incurred such as variable customer acquisition costs associated with generating new subscription fees. Investment income, net Investment income increased from $574,000 in the first quarter of 2000 to $674,000 for the same period in 2001 primarily due to the increase in invested cash and marketable securities resulting from the sale of newly issued equity securities totalling $44,000,000 in a private placement completed in 2000. Income taxes The income tax benefit on the loss from continuing operations in 2001 and 2000 is different from the U.S. statutory rate of 34%, primarily due to unbenefitted losses and tax credits. The Company has fully reserved its net deferred tax assets due to the uncertainty of future taxable income from the Company's business initiatives. Loss from continuing operations As a result of the foregoing, the Company experienced first quarter losses from continuing operations of $11,136,000 in 2000 and $13,610,000 in 2001. Discontinued Operations The Company recorded a gain of $48,000 for the three months ended March 31, 2001, primarily due to a reduction in estimated future costs for various indemnification issues associated with the disposal of its remaining operating businesses in 1998. LIQUIDITY AND CAPITAL RESOURCES At March 31, 2001, the Company's principal source of liquidity is its net working capital position of 10

11 $41,607,000, including cash and marketable securities of $43,239,000. The Company plans to invest its excess cash primarily in short-term, high-grade U.S. corporate debt securities or U.S. government and agency securities. The Company's first quarter 2001 loss from continuing operations included significant non-cash expenses such as depreciation and amortization, and stock-based compensation aggregating $6,808,000. Net cash used by continuing operations in the first quarter of 2001 was $6,569,000, primarily representing continued development and operating costs relating to the Company's Internet related businesses. The Company began charging for its ZixMail products and services in the first quarter of 2001. The Company's near-term liquidity will be negatively impacted as the Company continues its development stage activities, particularly with regards to discretionary marketing and advertising costs and costs associated with forming or supporting its strategic marketing partners, such as a minimum future commitment to Yahoo! totalling $5,025,000, payable in quarterly installments through August 2002. The trend for additions to property and equipment continues to decline with 2001 capital expenditures not expected to exceed $2,000,000. The Company has committed to make an additional $2,000,000 investment in Maptuit Corporation ("Maptuit"), payable in the Company's common stock or cash, in the near-term. Maptuit, an early stage company, is a privately-held Internet application service provider that supplies wireline and wireless Internet location-based services. Mr. Jeffrey P. Papows, a director of the Company since March 2000 and the Company's chairman of its board of directors since October 2000, serves as the president and chief executive officer of Maptuit and holds a minority equity interest in Maptuit. Additionally, in October 2001, the last installment for the delivery of stock issuable in connection with the purchase of Anacom, $3,232,000 of additional consideration in cash or stock at ZixIt's option would be required to be delivered assuming the market value of the Company's common stock at that time is equal to $12.48, the market value of the Company's common stock on April 30, 2001. The Company believes its existing net working capital position will be sufficient to meet near-term anticipated needs. The Company currently has no existing borrowings or credit facilities. Acquisitions, if any, would be financed by the most attractive alternative available, which could be cash or the issuance of debt or equity securities. RISKS AND UNCERTAINTIES The following is a "safe harbor" statement under the Private Securities Litigation Reform Act of 1995: Certain matters discussed in this Quarterly Report on Form 10-Q contain statements that constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. The words "expect," "estimate," "anticipate," "predict," "believe," "plan," "should," "goal" and similar expressions and variations thereof are intended to identify forward-looking statements. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those projected in the forward-looking statements as a result of various factors. These risks and uncertainties include, but are not limited to, the following: LIMITED OPERATING HISTORY IN INTERNET ARENA ZixIt's products and services are targeted at the new and rapidly evolving markets for secure Internet communications and e-commerce. Although the competitive environment in these markets has yet to fully develop, ZixIt anticipates that it will be intensely competitive, subject to rapid change and significantly affected by new products and service introductions and other market activities of industry participants. ZixIt has only a limited operating history in the Internet arena on which to base an evaluation of its business and prospects. ZixIt's prospects must be considered in light of the risks and uncertainties encountered by other Internet companies in the early stages of development. These risks and uncertainties are often more pronounced for companies in new and rapidly evolving markets, particularly Internet-related businesses. TIMELY DEVELOPMENT OF PRODUCTS AND SERVICES ZixIt must be able to successfully and timely develop its products and services. The commercial version of ZixMail was first released in March 2000. ZixIt's new Internet secure-messaging portal - ZixMail.net(TM) - was 11

12 first opened at the end of July 2000. ZixIt has not earned any significant revenues from its ZixMail products or services, although ZixIt first began charging for these products and services in the first quarter of 2001. ZixCharge(TM) has not been commercially released. MARKET ACCEPTANCE ZixIt must be able to achieve broad market acceptance for its products and services. To ZixIt's knowledge, there are currently no Internet secure-messaging services, such as ZixMail, that currently operate at the scale that ZixIt would require, at its current expenditure levels and proposed pricing, to become profitable from its secure-messaging operations. To reach a larger customer base for its secure-messaging products and services than ZixIt can reach through its direct sales and marketing efforts, ZixIt is pursuing collaborative relationships with third parties with large existing user bases to assist ZixIt in promoting its secure-messaging services. There is no assurance that ZixIt will be successful in entering into these relationships, or that if entered into, they will significantly assist ZixIt in obtaining large numbers of ZixMail users. Moreover, in any event, there is no assurance that enough paying users will ultimately be obtained to enable ZixIt to operate profitably. ZIXCHARGE UNCERTAINTIES Since the commercial version of ZixCharge has not yet been released, there are currently no consumers or merchants using ZixCharge. As noted in its periodic SEC filings, ZixIt has initiated litigation against Visa, which alleges that Visa set out to destroy ZixIt's ability to market ZixCharge. ZixIt believes it is unlikely that any Visa member banks will enter into any ZixCharge related collaborative relationship until the Visa litigation is resolved. Moreover, the resolution of this litigation could have a material effect on ZixIt's ability to market the ZixCharge system. NO SIGNIFICANT REVENUES ZixIt currently has no significant revenues. COMPETITION ZixIt is a new entrant into the rapidly evolving secure Internet communications and e-commerce markets. ZixIt will be competing with larger companies that have access to greater capital, research and development, marketing, distribution and other resources than it does. In addition, the Internet arena is characterized by extensive research efforts and rapid product development and technological change that could render ZixIt's products and services obsolete or noncompetitive. ZixIt's failure to develop and introduce new products and services successfully on a timely basis and to achieve market acceptance for those products and services could have a significant adverse effect on its business, financial condition and results of operations. ZixIt may decide, at any time, to delay, discontinue or not initiate the development and release of any one or more of its planned or contemplated products and services. Attempts have been made to define the size and nature of the market comprising secure Internet communications. A Robert W. Baird & Co. study of this market has coined the term "Secure e-Document Delivery Industry" to describe the activity and business within this sector. This report is instructive with respect to the competition within this market segment as it seeks to identify the market segments and to analyze the various participants. The analysis divides the secure e-document delivery industry into three segments: (1) email content management; (2) email statement creation and delivery and (3) secure messaging. The report identifies 26 companies that participate in one, two or all three of these market segments. These companies include: Aladdin Knowledge Systems, CertifiedMail.com, click2send, Content Technologies, Critical Path, Disappearing, Inc., e-Docs, eLynx, ePage, e-Parcel, Hushmail, MessagingDirect, MicroVault, NetEx, PostX, Private Express, Slam Dunk Networks, SRA International, Ten Four AB, Trend Micro, Tumbleweed Communications, United Parcel Service, ValiCert, Xenos, ZipLip and ZixIt. Not included in this listing are PGP (Pretty Good Privacy), a division of Network Associates and SigabaSecure. 12

13 While several of these companies participate in two or three of the market segments listed above, more than half -- 14 companies, including ZixIt -- focus only on the secure messaging segment. The report notes that this field is crowded because the technological requirements to compete in this space are widely available -- like public key infrastructure and encryption, as well as standard Internet and email protocols. While many of these companies compete with ZixIt, some of these companies do not. For example, although Slam Dunk Networks delivers messages securely, it does so within an enterprise-to- enterprise environment - the automated exchange of purchase orders between business partners, for example. Today, ZixIt participates primarily in the Desktop-to-Desktop market allowing individuals to transmit items like contracts, spreadsheets and other sensitive documents that are prepared on an ad hoc basis. Competition in this market includes, but is not limited to, CertifiedMail, Hushmail, PGP, Private Express, SigabaSecure and ZipLip. Although the foregoing analysis attempts to categorize and classify the secure e-document delivery market into specific niches, it is far too early in the evolution of this industry to accurately portray its structure. What may be viewed today as competitive relationships between two or more participants may, in the near future, become collaborative relationships. Thus, while assessment of the competition is a fundamental part of this analysis, the fluid nature of the evolving technology in this market could produce alliances between apparent competitors that are impossible to predict today. SECURITY INTERRUPTIONS AND SECURITY BREACHES ZixIt's business depends on the uninterrupted operation of its secure data center. ZixIt must protect this center from loss, damage or interruption caused by fire, power loss, telecommunications failure or other events beyond its control. Any damage or failure that causes interruptions in its secure data center operations could materially harm its business, financial condition and results of operations. In addition, ZixIt's ability to issue digitally-signed certified time-stamps and public encryption codes in connection with its ZixMail service and deliver messages through its ZixMail.net message portal depends on the efficient operation of the Internet connections between customers and ZixIt's data center. ZixIt depends 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 ZixIt's facilities and infrastructure remain secure and the market perceives them to be secure. Despite ZixIt's security measures, its infrastructure may be vulnerable to physical break-ins, computer viruses, attacks by hackers or similar disruptive problems. It is possible that ZixIt may have to use additional resources to address these problems. Messages sent through ZixIt's ZixMail.net message portal will reside, for a user-specified period of time, in its data center facilities. Also, ZixIt's planned ZixCharge business will retain certain confidential customer information in its data center facilities. Any physical or electronic break-ins or other security breaches or compromises of this information could expose ZixIt to significant liability, and customers could be reluctant to use its Internet-related products and services. KEY PERSONNEL ZixIt depends on the performance of its senior management team and other key employees, particularly highly skilled technical and sales and marketing personnel. ZixIt's success also depends on its ability to attract, retain and motivate these individuals. There is competition for these personnel, and ZixIt faces a tight employment market in general. There are no agreements with any of ZixIt's personnel that prevent them from leaving ZixIt at any time. In addition, ZixIt does not maintain key person life insurance for any of its personnel. The loss of the services of any of ZixIt's key employees or its failure to attract, retain and motivate key employees could harm its business. UNKNOWN DEFECTS OR ERRORS Any of ZixMail, ZixMail.net message portal or ZixCharge could contain undetected defects or errors. Despite ZixIt's testing, defects or errors may occur, which could result in loss of or delay in revenues, failure to 13

14 achieve market acceptance, diversion of development resources, injury to ZixIt's reputation, litigation claims, increased insurance costs or increased service and warranty costs. Any of these could harm ZixIt's business. PUBLIC KEY CRYPTOGRAPHY TECHNOLOGY ZixIt's products and services employ, and future products and services may employ, public key cryptography technology. With public key cryptography technology, a user has a public key and a private key, which are used to encrypt and decrypt messages. The security afforded by this technology depends, in large measure, on the integrity of a user's private key, which is dependent, in part, on the application of certain mathematical principles. The integrity of a user's private key is predicated on the assumption that it is difficult to mathematically derive a user's private key from the user's related public key. Should methods be developed that make it easier to derive a user's 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 ZixIt to make significant changes to its products, which could damage its reputation and otherwise hurt its business. Moreover, there have been public reports of the successful decryption of certain encrypted messages. This, or related, publicity could affect public perception of the security afforded by public key cryptography technology, which could harm ZixIt's business. GOVERNMENT REGULATION Exports of software products using encryption technology are generally restricted by the U.S. government. Although ZixIt has obtained U.S. government approval to export its ZixMail product to almost all countries in the world, the list of countries to which ZixMail cannot be exported could be revised in the future. Furthermore, some foreign countries impose restrictions on the use of software products using encryption technology, such as the ZixMail product. Failure to obtain the required governmental approvals would preclude ZixIt from selling the ZixMail product in international markets. LACK OF GENERALLY ACCEPTED STANDARDS There is no assurance that ZixIt's products and services will become generally accepted standards or that they will be compatible with any standards that become generally accepted. INTELLECTUAL PROPERTY RIGHTS ZixIt may have to defend its intellectual property rights or defend against claims that ZixIt is infringing the rights of others. Intellectual property litigation and controversies are disruptive and expensive. Infringement claims could require ZixIt 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 ZixIt. ZixIt's business could be significantly harmed if it is 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 ZixIt. SALE OF BUSINESSES ZixIt disposed of its remaining operating businesses in 1998 and 1997. In selling those businesses, ZixIt agreed to provide customary indemnification to the purchasers of those businesses for breaches of representations and warranties, covenants and other specified matters. Although ZixIt believes that it has adequately provided for future costs associated with these indemnification obligations, indemnifiable claims could exceed ZixIt's estimates. STOCK PRICE The market price of ZixIt's common stock has fluctuated significantly in the past and is likely to fluctuate in the future. Also, the market prices of securities of other Internet-related companies have been highly volatile and, as is well known, have declined substantially and broadly over the past several months. 14

15 OTHER UNANTICIPATED RISKS AND UNCERTAINTIES There are no assurances that ZixIt will be successful or that it will not encounter other, and even unanticipated, risks. ZixIt discusses other operating, financial or legal risks or uncertainties in its periodic SEC filings. ZixIt is, of course, also subject to general economic risks. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK For the period ended March 31, 2001, the Company did not experience any material changes in market risk exposures with respect to its cash investments and marketable securities that affect the quantitative and qualitative disclosures presented in the Company's 2000 Annual Report to Shareholders on Form 10-K. The Company has made an equity investment in Maptuit Corporation, an early stage privately-held company. There is no readily determinable market value for the Company's investment in Maptuit Corporation. Investments of this nature are subject to significant fluctuations in fair market value due to the volatility of the equity markets. The Company identifies and records impairment losses when events and circumstances indicate the investment has been impaired. PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits The following is a list of exhibits filed as part of this Quarterly Report on Form 10-Q. DESCRIPTION OF EXHIBITS 3.1 Articles of Incorporation, together with all amendments thereto (filed as Exhibit 3.1 to the Company's Form 10-K for the year ended December 31, 1998, and incorporated herein by reference). Articles of Amendment to Articles of Incorporation, dated September 14, 1999 (filed as Exhibit 3.2 to the Company's Form 10-Q for the quarterly period ended September 30, 1999, and incorporated herein by reference). Articles of Amendment to Articles of Incorporation, dated October 12, 1999 (filed as Exhibit 3.3 to the Company's Form 10-Q for the quarterly period ended September 30, 1999, and incorporated herein by reference). 3.2 Restated Bylaws of ZixIt Corporation, dated September 14, 1999 (filed as Exhibit 3.2 to the Company's Form 10-Q for the quarterly period ended March 31, 2000, and incorporated herein by reference). *10.1 ZixIt Corporation 2001 Employee Stock Option Plan, dated May 4, 2001. b. Reports on Form 8-K No reports of the Registrant on Form 8-K have been filed with the Securities and Exchange Commission during the three months ended March 31, 2001. *Filed herewith. 15

16 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. ZIXIT CORPORATION (Registrant) Date: May 14, 2001 By: /s/ Steve M. York -------------------------------- Steve M. York Senior Vice President, Chief Financial Officer, and Treasurer (Principal Financial Officer and Duly Authorized Officer) 16

17 INDEX TO EXHIBITS EXHIBIT NUMBER DESCRIPTION - ------ ----------- 3.1 Articles of Incorporation, together with all amendments thereto (filed as Exhibit 3.1 to the Company's Form 10-K for the year ended December 31, 1998, and incorporated herein by reference). Articles of Amendment to Articles of Incorporation, dated September 14, 1999 (filed as Exhibit 3.2 to the Company's Form 10-Q for the quarterly period ended September 30, 1999, and incorporated herein by reference). Articles of Amendment to Articles of Incorporation, dated October 12, 1999 (filed as Exhibit 3.3 to the Company's Form 10-Q for the quarterly period ended September 30, 1999, and incorporated herein by reference). 3.2 Restated Bylaws of ZixIt Corporation, dated September 14, 1999 (filed as Exhibit 3.2 to the Company's Form 10-Q for the quarterly period ended March 31, 2000, and incorporated herein by reference). *10.1 ZixIt Corporation 2001 Employee Stock Option Plan, dated May 4, 2001. * Filed herewith

1 EXHIBIT 10.1 ZIXIT CORPORATION 2001 EMPLOYEE STOCK OPTION PLAN SECTION 1. PURPOSE The purpose of the ZixIt Corporation 2001 Employee 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, 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. "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. "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 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. "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 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. "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. 1

2 "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 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 All employees and non-employee consultants and advisors (other than officers of the Company and members of the Board of 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 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 Plan shall be a total of 300,000 shares of Common Stock. Options that expire, lapse or are cancelled or forfeited nonetheless continue to count against the 300,000 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. 2

3 (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. (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 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) 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 3

4 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 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 Designated Beneficiary 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) The Plan was originally effective on May 4, 2001. No Options may be granted under the Plan after May 3, 2011; however, all previous Options issued that have not expired under their original terms or will not then expire at the time the Plan expires will remain outstanding. 4

5 (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 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 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. (i) 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. (j) 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. (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. IN WITNESS WHEREOF, the Company has caused the Plan to be executed on its behalf as of the 4th day of May 2001. ZIXIT CORPORATION By: /s/ Ronald A. Woessner --------------------------- Title: S.V.P. ------------------------ Date: 5/7/01 ------------------------- 5