release a new version of our PocketScript technology during the first quarter of 2009, which delivers all necessary features to address new certification requirements for SureScripts-RxHub. Some of these features will be very beneficial to payors as they extend the breadth of insurance related decision support data to be delivered electronically via new standards and support additional prescription drug plans including those associated with Medicare

• Renewal rates for the Email Encryption Service;

• Additional payor sponsorship of the e-Prescribing Service to physicians by new or existing insurance payors;

• Successful adoption and usage of the e-Prescribing Service by physicians;

• Retention of the users (physicians) of the e-Prescribing Service as indicated by subscription renewals;

• Future transaction fees (or related fees) associated with the use of the e-Prescribing Service; and

• Our ability to increase business volume with reasonable cost increases.

Known trends regarding these key metrics and their implication on our current and future capital requirements are discussed throughout this "Management's Discussion and Analysis of Financial Condition and Results of Operations"
("MD&A")
There are no assurances we will be successful in our efforts to achieve these key metrics. Our continued growth depends on the timely development and market acceptance of our products and services. We have experienced improved fundamentals in our cash flow performance during 2008 - for the first time in our history we were cash flow positive. We will continue to place a strong emphasis on actions to improve our cash flow, while balancing the need for investments in our developing and emerging markets. See "Item 1A. Risk Factors" for more information on the risks relevant to our operations and future prospects.
Revenue
Revenue increased by 16% in 2008 compared with 2007. Our growth was driven by a 26% increase in the revenue for our Email Encryption business where our successful subscription model yielded steady additions to the subscriber base - coupled with a high rate of renewing existing customers. The increase from our Email segment was partially offset by a decrease in our e-Prescribing segment where we saw a reduction in our transaction related fees from one customer and in our deployments during 2008.
Operating Margins
For the year ended 2008, our gross margin percentage increased almost 20% compared with 2007. This increase was primarily driven by increased revenues from our Email segment and a reduction in cost of revenues in our e-Prescribing segment where we deployed fewer physicians during 2008. Our headcount increased in 2008, reflecting investments in research and development (R&D), sales and executive management.
Other Financial Highlights
• For Email Encryption, our sales backlog was $34.7 million in 2008, compared with $28.3 at the end of 2007

• For Email Encryption, our total orders for 2008 were $29.2 million, an increase of 21% from the 2007 total orders of $24.2 million

• Our deferred revenue at the end of 2008 was $17.4 million, compared with $16.1 million at the end of 2007

• We generated cash flows from operations of $2.1 million. Our cash and cash equivalents, together with our investments, were $13.2 million at the end of 2008, compared with $12.3 million at the end of 2007

• We maintained a strong renewal rate for eligible Email Encryption contracts at 94% for 2008

• We topped 15 million user Email addresses with our Email Encryption Service, with an increased growth

rate of approximately 100,000 new Email addresses each week

• Our e-Prescribing Service signed four new sponsorship contracts during the year

• Our e-Prescribing Service processed approximately 8.6 million e-scripts during 2008, an increase of 16% over 2007

Critical Accounting Policies and Estimates In preparing our consolidated financial statements, we make estimates, assumptions and judgments that can have a significant impact on revenue, loss from operations and net loss, as well as the value of certain assets and liabilities on our consolidated balance sheet. The application of our critical accounting policies requires an evaluation of a number of complex criteria and significant accounting judgments by us. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. We evaluate our estimates on a regular basis and make changes accordingly. Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of our Board of Directors. Actual results may materially differ from these estimates under different assumptions or conditions. If actual results were to differ from these estimates materially, the resulting changes could have a material adverse effect on the consolidated financial statements.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about complex matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements. Management believes the following critical accounting policies reflect our more significant estimates and assumptions used in the preparation of the consolidated financial statements.
Our critical accounting policies are as follows:
• Revenue recognition

• Income taxes

• Valuation of goodwill and other intangible assets

• Stock-based compensation costs

For additional discussion of the Company's significant accounting policies, refer to Note 2 to the consolidated financial statements.
Revenue Recognition
We must make significant management judgments and estimates to determine revenue to be recognized in an accounting period. Material differences may result in the amount and timing of our revenue for any period if our management made different judgments or utilized different estimates. These estimates affect the deferred revenue on our consolidated balance sheet and revenue on our consolidated statements of operations. Estimates regarding revenue affect all of our operating geographies.
We apply the provisions of the EITF Abstract No. 00-21, "Revenue Arrangements with Multiple Deliverables," Securities and Exchange Commission Staff Accounting Bulletin No. 104, "Revenue Recognition in Financial Statements" and other related pronouncements.
Generally speaking, we develop, market and support applications that connect, protect and deliver information in a secure manner. Our services can be placed into several key revenue categories where each category has similar revenue recognition traits: Email Encryption and e-Prescribing subscription-based services, various transaction fees and related professional services. The majority of the revenues generated are through direct sales; however, our Email Encryption Service employs a combination of direct sales and a network of distributors and resellers.
Under all product categories and distribution models, we recognize revenue after all of the following occur:

• persuasive evidence of an arrangement exists,

• delivery has occurred or services have been rendered,

• the price is fixed and determinable, and

• collectability is reasonably assured.

In the event the arrangement has multiple elements with delivered and undelivered elements, revenue for the delivered elements is recognized under the residual method only when Vendor Specific Objective Evidence ("VSOE") exists to allocate the fair value of the total fees to the undelivered elements of the arrangement.
When we are engaged in a complex product deployment, customer acceptance may have to occur before the transaction is considered complete. In this situation, no revenue is recognized until the customer accepts the product. Discounts provided to customers are recorded as reductions in revenue.
Both the Email Encryption and the e-Prescribing Services are subscription-based services. Providing these services includes delivering subscribed-for-software and providing secure electronic communications and customer support throughout the subscription period. Our subscribers generally execute multiple-year contracts that are irrevocable and non-refundable in nature and require annual, up-front payments. Subscription fees received from customers are initially recorded as deferred revenue and then recognized as revenue ratably over the subscription period.
Some of our e-Prescribing Services incorporate a transaction fee per event occurrence or when predetermined usage levels have been reached. These fees are recognized as revenue when the transaction occurs or when the predetermined usage levels have been achieved, and when the amounts are fixed and determinable.
We do not offer stand alone services. Further, our services primarily include manufacturer provided warranty provisions. We recorded no warranty expense in any of the presented periods.
Income Taxes
Two critical elements of our overall accounting for income taxes pertain to the valuation of our deferred tax assets in accordance with the provisions of SFAS No. 109, "Accounting for Income Taxes," and our adoption of the provisions of FASB Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109 Accounting for Income Taxes," effective January 1, 2007.
Deferred tax assets are recognized if it is "more likely than not" that the benefit of the deferred tax asset will be realized on future federal income tax returns. At December 31, 2008, we continued to provide a full valuation allowance against most of our accumulated U.S. deferred tax assets of $111,994,000, reflecting our historical losses and the uncertainty of future taxable income. Our total deferred tax asset not subject to a valuation allowance, is valued at $72,000, and consists of $48,000 for U.S. state income tax credits that are substantially certain of realization in 2009 because the underlying tax is not contingent on U.S. profitability and $24,000 for a Canadian deferred tax asset relating to temporary timing differences between GAAP and tax-related expense. If we begin to generate U.S. taxable income in a future period or if the facts and circumstances on which our 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 our deferred tax assets will be realized.
FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Prior to the adoption of FIN 48, we had recorded a $327,000 tax contingency liability and that amount and the specifics therein have remained unchanged. As of December 31, 2008, the gross amount of our unrecognized tax benefits, inclusive of the $327,000 tax liability, was approximately $377,000. Included in this balance are tax positions which, if recognized, would impact our effective tax rate.

Valuation of Goodwill and Other Intangible Assets We account for the valuation of goodwill and other intangible assets in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," which classifies intangible assets into three categories: (1) intangible assets with definite lives subject to amortization; (2) intangible assets with indefinite lives not subject to amortization; and (3) goodwill. For intangible assets with definite lives, tests for impairment must be performed if conditions exist that indicate that the carrying value may not be recoverable. For intangible assets with indefinite lives and goodwill, tests for impairment must be performed at least annually or more frequently if events or circumstances indicate that assets might be impaired. We have intangible assets with definite lives subject to amortization, which became fully amortized in early 2007 following their costs being ratably amortized over their respective, estimated useful lives of three years. We have no intangible assets with indefinite lives not subject to amortization.
Our goodwill totaled $2,161,000, or 11% of total assets at December 31, 2008 and 2007, which represents the remaining cost in excess of fair value of net assets acquired in the 2003 acquisition of Elron Software and its subsequent sale in 2005.
Our goodwill is not being amortized, but we do evaluate the goodwill for impairment annually in the fourth quarter, 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 reporting unit to which the goodwill has been assigned to, versus the sum of the carrying value of the assets and liabilities of that unit including the assigned goodwill value. The fair values used in this evaluation are estimated based on the Company's market capitalization, which is based on the outstanding stock and market price of the stock. Impairment is deemed to exist if the net book value of the unit exceeds its estimated fair value.
Stock-based Compensation Expense
On January 1, 2006, we adopted SFAS 123(R), "Share-Based Payment," which is a revision of SFAS 123, "Accounting for Stock-Based Compensation" and supersedes the provisions of Accounting Principles Board ("APB") No. 25, "Accounting for Stock Issued to Employees." Our adoption was on a prospective basis with the straight-line amortization method for recognizing stock option compensation costs. For periods prior to January 1, 2006, we used the intrinsic value method to account for stock-based compensation plans under the provisions of APB 25. Our share-based awards are limited to stock options.
SFAS 123(R) requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees, directors or outside service providers based on the estimated fair value of an award on the grant date. This standard requires grant date fair value to be estimated using either an option-pricing model which is consistent with the terms of the award or a market observed price, if such a price exists. Such cost must be recognized over the period during which an employee, director or outside service provider is required to provide service in exchange for the award, i.e., "the requisite service period" (which is usually the vesting period). The standard also requires us to estimate the number of instruments that will ultimately be earned, rather than accounting for forfeitures as they occur.
We used the Black-Scholes Option Pricing Model ("BSOPM") to determine the fair value of option grants made during 2008, 2007, and 2006. Commencing on January 1, 2006, we elected to use the "simplified" method per SEC Staff Accounting Bulletins No. 107 ("SAB 107"), "Share Based Payment,"to calculate the estimated life of options granted to employees. The use of the "simplified" method under SAB 107 was extended beyond December 31, 2007 in accordance with Staff Accounting Bulletin 110, "Share Based Payment," issued on December 21, 2007, until such time when we have sufficient information to make more refined estimates on the estimated life of our options. The expected stock price volatility was calculated by averaging the historical volatility of our common stock over a term equal to the expected life of the options.
The following weighted average assumptions were applied in determining the fair value of options granted during the respective periods:

                                                  Year Ended December 31,
                                                2008          2007       2006
            Risk-free interest rate               2.57 %       3.81 %     4.59 %
            Expected option life (years)           5.8          5.8        5.8
            Expected stock price volatility         78 %         81 %       93 %
            Expected dividend yield                  -            -          -
            Fair value of options granted     $   1.71       $ 2.87     $ 1.03

The assumptions used in the BSOPM valuation are critical as a change in any given factor could have a material impact on the financial results of the Company.
Full Year 2008 Summary of Operations
Financial
• Revenue for 2008 was $28,035,000 from all products compared with $24,114,000 in 2007 and $18,358,000 in 2006.

• Gross margin for 2008 was $18,185,000 or 65% of revenues compared to $13,248,000 or 55% of revenues in 2007.

Email Encryption - gross margin for this segment was $18,499,000 or 82% of revenues compared to $13,621,000 or 76% of revenues in 2007.
e-prescribing - gross loss for this segment was $314,000 or a negative 6% of revenues compared to a loss of $373,000 or a negative 6% of revenues in 2007.

• Net loss for the year 2008 was $5,442,000 compared with $8,102,000 in 2007 and $19,508,000 in 2006.

• Ending unrestricted cash was $13,245,000 and the balance in restricted accounts was $28,000 on December 31, 2008.

Results of Operations

Revenues
   The following table sets forth a year-over-year comparison of our total
revenues by product lines:

                                                                                          Variance                        Variance
                                      Year Ended December 31,                          2008 vs. 2007                   2007 vs. 2006
                             2008               2007               2006                $              %                $              %
Email Encryption         $ 22,604,000       $ 17,982,000       $ 14,094,000       $ 4,622,000           26 %      $ 3,888,000           28 %
e-Prescribing               5,431,000          6,132,000          4,264,000          (701,000 )        (11 %)       1,868,000           44 %

Total revenues           $ 28,035,000       $ 24,114,000       $ 18,358,000       $ 3,921,000           16 %      $ 5,756,000           31 %

Email Encryption -Revenue increases were driven primarily by our continual addition of new users to the subscriber base, while at the same time renewing a high percentage of existing subscribers whose subscriptions were up for renewal. We measure additions to the subscriber base by NFYO, which is defined as the portion of new orders that are expected to be recognized into revenue in the first twelve months of the contract. NFYOs and renewal percentages are summarized in the table below:

                                         2008            2007            2006
         New first year order value   $ 5,460,000     $ 5,514,000     $ 4,665,000
         Renewal percentage                    94 %            99 %            95 %

We perceive an annual change in renewal percentages of approximately 5%, either up or down, to be reasonable and can be due singularly to, or in combination with, new competition entering the marketplace, existing competition introducing new features to their comparable service offerings, pure price competition, and/or consolidation of our customer's business. Renewal customers are normally renewed at a price equal to or greater than the price of their previous service period.
Our go-to-market model of selling involves primarily multiple-year subscription contracts with the fees paid annually at the inception of each year of service. As a result, a high percentage of customers subscribe to the Email Encryption Service for a three-year term versus a one-year term. We expect this preference for a longer contract term by a high percentage of our customers to continue in 2009, as we have priced our services in a manner that

encourages longer-term contractual commitments from customers.
Our list pricing for Email Encryption has remained generally consistent in 2008 when compared with 2007, although we did announce a slight price increase for our services effective in January 2008. We have experienced relatively consistent discount percentages off our list price during the periods shown above.
There are no assurances that potential increased competition in this market or other factors will not result in future price erosion. Price erosion, should it occur, could have a dampening effect on our new orders and/or renewal rates as previously discussed.
e-Prescribing - The decrease in revenue between 2008 and 2007 was largely due to reaching an upper-invoicing limit associated with transaction fees for a single payor contract. One-time projects occurring in 2007 also contributed to the decrease in revenues when compared to 2008. Additionally, the impact of fewer e-Prescribing deployments in 2008 (approximately 725 deployments in 2008 versus approximately 1,950 in 2007) contributed to the decline in deployment revenue year-over-year but to a lesser extent. These decreases were partially offset by an increase in renewal revenues.
The increase in 2007 revenues versus 2006 was primarily driven by an increase in renewal revenues and transaction/usage-based fees. Revenue on deployments to new PocketScript users and revenues relating to one-time projects increased slightly.
Revenue Outlook:
Our future revenue growth in 2009 is primarily expected to come from continued success in the Email Encryption business.
With Email Encryption, we anticipate that with our continued focus on sectors such as healthcare, financial services, insurance and government, along with the increased use of indirect OEM distribution channels, we expect to see the business increase its new first year order rate in 2009 and fuel an overall, year-over-year revenue growth rate that is similar to 2008. . . .