Overview
We are a leader in providing secure, Internet-based applications in a Software as a Service ("SaaS") model. Our core competency is the ability to deliver these complex service offerings with a high level of availability, reliability, integrity, and - particularly - security. We operate under two reporting segments, Email Encryption Service ("Email" or "Email Encryption") and e-Prescribing Service ("e-Prescribing") where we offer these services on a subscription basis to our customers who subscribe to use the services for a specified term.
The business operations and service offerings are supported by the ZixData Center™, a network operations center dedicated to secure electronic transaction processing. The operations of the ZixData Center are independently audited annually to maintain AICPA SysTrust™ certification in the areas of security, confidentiality, integrity and availability. Auditors also produce a SAS70 Type II report on the effectiveness of operational controls used over the audit period. The center is staffed 24 hours a day with a proven 99.99% reliability. Whether it is delivery of email, prescriptions or other sensitive information, we enable communications to be sent in a trusted, safe, and secure manner. This is our core competency and we believe it is a competitive advantage. Critical Accounting Policies and Estimates 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 condensed 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.
We describe our significant accounting policies in Note 2, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements included in our 2008 Form 10-K. We discuss our Critical Accounting Policies and Estimates in Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2008 Form 10-K. Results of Operations
First Quarter 2009 Summary of Operations Financial
• Revenue for the quarter ended March 31, 2009, was $7,256,000 compared with $7,199,000 for the same period in 2008 representing a 1% increase.

• Gross profit for the quarter ended March 31, 2009, was $4,785,000 or 66% of revenues compared with $4,619,000 or 64% of revenues for the comparable period in 2008.

Email Encryption - gross profit was $5,229,000 or 84% of revenues compared with $4,239,000 or 80% of revenues for the comparable period in 2008.

e-Prescribing - gross loss was $444,000 or 44% of revenues compared with gross profit of $380,000 or a 20% of revenues for the comparable period in 2008.

• Net loss for the quarter ended March 31, 2009 was $1,542,000 compared with a net loss of $1,704,000 in 2008.

• Ending cash and cash equivalents were $12,228,000 on March 31, 2009 compared with $13,245,000 on December 31, 2008.

Operations
• For the Email Encryption service, new first year orders ("NFYO" or "NFYOs") for the quarter ended March 31, 2009, were $1,130,000 and customer contract renewals were 95% on a contract value basis.

• We deployed approximately 350 new e-Prescribing devices to prescribers and reached approximately 2,500,000 electronic prescriptions transacted in the three-month period ended March 31, 2009 (12% higher than the same period in 2008).

   Revenues
   Email Encryption and e-Prescribing are primarily subscription-based services.
The following table sets forth a quarter-over-quarter comparison of the
Company's revenues:

                                 Three Months Ended            3-month Variance
                                      March 31,                  2009 vs. 2008
                                2009            2008              $            %
          Email Encryption   $ 6,242,000     $ 5,289,000         953,000        18 %
          e-Prescribing        1,014,000       1,910,000        (896,000 )     (47 %)

          Total revenues     $ 7,256,000     $ 7,199,000          57,000         1 %

The increase in Email Encryption revenue was due to the growth inherent in a successful subscription model with steady additions to the subscriber base coupled with a high rate of renewing existing customers. The decline in e-Prescribing revenue was driven primarily by fewer new prescriber deployments in 2008 and early 2009 compared with 2007, which led to a decline in deployment fees, a drop in fee revenue after reaching a contractual cap in one customer program, and a first quarter 2008 one-time revenue catch-up involving the achievement of deployment-related metrics for a single customer contract.
Revenue Indicators - Backlog, Orders and Deployments Company-wide backlog - Our end-user order backlog totals $38,354,000 and is comprised of contractually bound agreements that we expect to fully amortize into revenue. As of March 31, 2009, the backlog was comprised of the following elements: $16,965,000 of deferred revenue that has been billed and paid, $4,429,000 billed but unpaid, and approximately $16,960,000 of unbilled contracts. The total backlog divided by segment was $35,599,000 for Email Encryption and $2,755,000 for e-Prescribing.
Our backlog is recognized into revenue as the services are performed. Approximately 60% of the total backlog is expected to be recognized as revenue during the next twelve months. The timing of revenue is affected by both the length of time required to deploy a service and the length of the service contract.
Email Encryption Orders - Total orders for Email Encryption were $7,399,000 and $8,700,000 for the three-month periods ended March 31, 2009 and 2008, respectively. Total orders include customer orders that management separates into three components for measurement purposes: contract renewals, NFYOs, and in the case of new multi-year contracts, the years beyond the first year of service. NFYOs were $1,130,000 and $1,432,000 for the three months ended March 31, 2009 and 2008, respectively. We believe the softness in our NFYO's was driven in large part by the slow economy, as well as competition.
e-Prescribing - In e-Prescribing, we have built a prescriber base by contracting with a number of health insurance companies ("payors") to pay for (i.e. "sponsor") physicians in their network to receive the e-Prescribing Service at no charge to the prescriber for at least the first year of service. e-Prescribing revenue has declined, in part, due to the number of deployments falling to 840 deployments in the twelve months ended March 31, 2009, from 1,650 in the twelve months ended March 31, 2008. However, we have been successful during the past two quarters in signing additional contracts and at March 31, 2009, we have approximately 620 sponsored, but not-yet-deployed prescribers in our backlog. At our current deployment rates, we cannot achieve our objectives for the e-Prescribing business of becoming cash flow breakeven on a stand-alone basis in the near-term. Absent our signing any additional new contracts, we expect e-Prescribing revenues to remain relatively flat throughout 2009. Even if we do sign new contracts, revenues could remain flat because of the lead times between contract signing, physician recruitment and deployment, which are required for revenue recognition, could be three to six months. There can be no assurance we will be successful in expanding our current payor programs or contracting with new payors. If we are not successful in this effort and do not reduce the related operating expenses, then the e-Prescribing line of business will continue to consume cash, and revenues will decline beginning first quarter 2010.
We expect our business model, particularly as it relates to our e-Prescribing deployments, to evolve into a longer pay-back period, i.e., our up-front investment in new deployments becoming subject to recoupment over a longer period of time than we have historically experienced. In light of the new MIPPA legislation, we have increased the list price for e-Prescribing renewals in 2009 to $720 annually, and we are also considering new ways to expand sources for initial deployment funding. Along with increasing prescriber sponsorships, future revenue growth is dependent on increasing utilization and retention by the sponsored physicians; renewing service contracts for active prescribers; and developing additional transaction-based and incremental service fees for new functionality.
The level of active users represents the portion of the total deployed base that is using the service on a consistent basis, making it a key indicator for retention and future revenue opportunity. In recent quarters, an average of 70% to 75% of deployed prescribers have become active users. As of March 31, 2009, approximately 3,250 active prescribers were using our service, compared to approximately 3,350 at March 31, 2008. The reduction in the number of active prescribers resulted from attrition in the ordinary course of business, partially offset by newly deployed prescribers. We continue our efforts to identify solutions for improving the conversion rate of deployed users to active users and for lowering the attrition rate.
A large clinic, which accounts for approximately 15% of our total active prescribers, has notified us that they will discontinue our e-Prescribing Service in 2009 as they complete their migration to a full electronic medical record solution. Based on the end date of their current service periods and due to the special pricing they receive, the revenue impact in calendar 2009 is expected to be approximately $20,000, while the annualized loss in revenue resulting from this event is estimated at approximately $150,000.
We recognized $204,000 in total transaction and usage-based fees revenue in the quarter ended March 31, 2009, compared to $537,000 in the same period 2008. This decrease was due to our reaching an upper invoicing limit associated with the usage-based

fees included in a single payor contract in the second quarter 2008. The Company currently earns transaction-based fees (or the equivalent) with two health care payors, having reached the contract expiration on such fees with a third payor during the first quarter 2009. Nonetheless, we will continue to pursue revenue opportunities from transaction fees from both new and existing customers. In most cases, there are multiple payors in each market and we believe that those additional non-sponsorship payors may be potential sources for supplemental fees in return for certain services such as formulary display, disease management enrollment, branding, and reporting.
Other sources for transaction fee revenue include parties who benefit from a real-time, electronic connectivity with PocketScript users. For example, we currently have contracts under which we earn fees for sending prescriptions electronically to the pharmacies and for certain transactions involving mail order prescriptions. The number of prescriptions written using the PocketScript Service and transmitted through the ZixData Center™ has continued to grow, with approximately 2.5 million prescriptions transacted in the first quarter of 2009 versus approximately 2.2 million prescriptions in the comparable 2008 period.
Recently enacted national healthcare legislation indicates interest on the part of the nation's lawmakers for improving the healthcare system. Beginning with MIPPA in July 2008 and the more recently enacted American Recovery and Reinvestment Act of 2009, which includes a health IT component labeled the HITECH Act, our U.S. lawmakers have indicated that healthcare technology will play a key role in improving the nation's healthcare system. Electronic prescribing is specifically listed in the 2009 legislation as part of a qualified electronic health record ("EHR") system. As healthcare technologies' role in the improvement of the nation's healthcare system continues to evolve, we will continue to evaluate all aspects of our e-Prescribing business and the best way to capitalize on upcoming developments. Cost of Revenues
The following table sets forth a quarter-over-quarter comparison of the cost of revenues by product line.

                                    Three Months Ended             3-month Variance
                                         March 31,                  2009 vs. 2008
                                   2009            2008               $            %
       Email Encryption         $ 1,013,000     $ 1,050,000           (37,000 )     (4 %)
       e-Prescribing              1,458,000       1,530,000           (72,000 )     (5 %)

       Total cost of revenues   $ 2,471,000     $ 2,580,000          (109,000 )     (4 %)

The cost of revenues improvement for the three-month period ended March 31, 2009 versus the three-month period ended March 31, 2008 resulted primarily from
(i) a $64,000 decrease in salary and benefits for individuals performing deployment activities due to a decrease in average headcount, primarily in the e-Prescribing product line, and (ii) a $71,000 decrease in occupancy costs primarily related to telecommunication costs across both product lines, as well as other decreases in various non-people costs primarily associated with decreased deployments of our e-Prescribing product. These cost reductions were partially offset by a $47,000 increase in stock-based compensation expense. Email Encryption - Email Encryption's cost of revenues is comprised of costs related to operating and maintaining the ZixData Center, a field deployment team, customer service and support and the amortization of Company-owned, customer-based computer appliances. For Email Encryption, a significant portion of the total cost of revenues relates to the ZixData Center, which currently has excess capacity. Accordingly, cost of revenues is relatively fixed in nature and is expected to grow at a much slower pace than revenue. e-Prescribing - e-Prescribing's cost of revenues is comprised of costs related to operating and maintaining the ZixData Center, a field prescriber recruiting team, a field deployment team, customer service and support, training and e-Prescribing device costs. In e-Prescribing, a greater proportion of total cost of revenues relates to prescriber recruiting and field deployment activities and device costs. These are more variable in nature than the ZixData Center and accordingly, e-Prescribing costs are more closely correlated to demand. Thus, an increase in our deployment activities will result in an increase in our year-over-year costs of revenues.

Research and Development Expenses
The following table sets forth a quarter-over-quarter comparison of our research and development expenses:

Three Months Ended 3-month Variance March 31, 2009 vs. 2008 2009 2008 $ % Research and development $ 1,731,000 $ 1,545,000 186,000 12 %

Research and development expenses consist primarily of salary, benefits, and stock-based compensation for our development staff, and other non-people costs associated with enhancing our existing products and services and developing new products and services. The increase in research and development expense in 2009 compared to 2008 was primarily attributable to (i) a $126,000 increase in salary and benefit expense resulting from an increase in average headcount and salary increases involving both product lines, (ii) a $36,000 increase in stock-based compensation expense and (iii) a $28,000 increase in IT services, partially offset by decreases in various other non-people expenses associated with research and development activities. New development activities were primarily those related to significant e-Prescribing enhancements to formulary and benefits presentation and prescriber workflow included in the latest release (i.e., version 6.9) of our e-Prescribing service. We also continued to make investments to strengthen our Email Encryption services which included work on a new customer-facing Encrypted Email reporting capability, a number of OEM-led international product capabilities and configuration options for our core product offerings as well as an upgrade of our Email Encryption audit software to significantly improve process efficiency and integrity.
Selling, General and Administrative Expenses The following table sets forth a quarter-over-quarter comparison of our selling, general and administrative expenses:

Three Months Ended 3-month Variance March 31, 2009 vs. 2008 2009 2008 $ % Selling, general and administrative $ 4,644,000 $ 4,817,000 (173,000 ) (4 %)

Selling, general and administrative expenses consist primarily of salary, stock-based compensation and benefit costs for marketing, selling, executive and administrative personnel as well as costs associated with advertising, promotions, professional services and general corporate activities. The decrease in SG&A expenses in the first quarter of 2009 compared to the same quarter in 2008 reflected (i) a $225,000 reduction across several spending categories including consulting, advertising, legal and audit fees and travel expenses and
(ii) a $66,000 reduction in salary and benefit costs due to lower average headcount. These reductions were partially offset by (i) an increase of $99,000 in stock-based compensation expense and (ii) increases in various other expenses related to selling, general and administrative activities.
Investment and Other Income
Investment income was $68,000 and $116,000 for the quarters ended March 31, 2009 and 2008, respectively. The decrease was primarily due to slightly lower cash balances in 2009 and a drop in interest rates between periods.
Provision for Income Taxes
Provision for income taxes was $20,000 and $77,000 for the three-month periods ended March 31, 2009 and 2008, respectively. The operating losses incurred by the Company's U.S. operations and the resulting net operating losses for U.S. Federal tax purposes are subject to a $112,214,000 reserve because of the uncertainty of future taxable income. As a result, our 2009 provision of $20,000 consists of taxes on our Canadian operation totaling $51,000, a small amount of state taxes based on gross revenues and a $35,000 refund for historical U.S. tax credits under certain provisions of the American Recovery and Reinvestment Act of 2009. The 2008 provision relates to taxes on our Canadian operation.
We have adopted Financial Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN 48"). Accordingly, there was an insignificant amount of interest expense accrued or recognized related to income taxes for the three-month periods ended March 31, 2009 and 2008, respectively. There were no penalty-related charges to selling, general and administrative expenses accrued or recognized for the same comparative periods. Additionally, we have not taken a tax position that would have a material effect on the financial statements or the effective tax rate for the three-month period ended March 31, 2009. We are currently subject to a three-year statute of limitations by major tax jurisdictions.

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 March 31, 2009, the gross amount of our unrecognized tax benefits, inclusive of the $327,000 tax liability was approximately $369,000. Included in this balance are tax positions which, if recognized, would impact our effective tax rate.
As indicated earlier, the operating losses incurred by our U.S. operations and the resulting net operating losses for U.S. Federal tax purposes are subject to a reserve. Significant judgment is required in determining any reserve recorded against the deferred tax asset. In assessing the need for a reserve, we consider all available evidence, including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies.
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 reserve no longer required. Reversal of all or a part of this reserve 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. Additionally, deferred tax assets may be limited in whole or in part by Internal Revenue Code
Section 382. As a result, our ability to fully utilize the deferred tax assets, including net operating loss carry forwards, against future taxable income may be limited.
Liquidity and Capital Resources
Overview
Based on our performance over the last four quarters and current expectations, we believe our cash and cash equivalents, and cash generated from operations, will satisfy our working capital needs, capital expenditures, investment requirements, contractual obligations, commitments, future customer financings, and other liquidity requirements associated with our operations through at least the next twelve months. However, we operate only two segments, one of which is still developing and emerging, which makes predicting future cash flows more difficult. We plan for and measure our liquidity and capital resources through an annual budgeting process. At March 31, 2009, our cash and cash equivalents totaled $12.2 million and we did not have any debt.
We operate two distinct business segments which are in different stages of their life cycle. Our Email Encryption segment is profitable and its revenue is growing at approximately 25% a year. Our e-Prescribing segment is generating significant losses and consuming cash while still in an emerging phase. Both are subscription businesses that share a common business model. First, the service is established and maintained, which requires a start-up cost and recurring fixed costs. Subscribers are then acquired and brought onto the service, which requires variable acquisition costs related to recruitment, installation and deployment. Subscribers are recruited with the goal of reaching a level of subscriber payments that exceed the fixed recurring service costs. Therefore, both the rate at which new subscribers are added and the ability to retain subscribers is essential to operational cash flow.
The recurring nature of the Email Encryption subscription model makes cash receipts naturally rise in a predictable manner assuming adequate subscription renewal and continued new additions to the subscription base. Adding to the predictability is our model of selling primarily three year contracts with the fees paid annually at the inception of each year of service. Although our Email Encryption segment is profitable and easier to predict, we continue to closely monitor developments in the e-Prescribing market and expect to adjust spending in this area commensurate with expected financial performance.
Cash and cash equivalents at March 31, 2009 were $12,228,000 down $1,017,000 from the December 31, 2008 balance, reflecting a timing difference in payments of $1,100,000 from two long-time customers expected in the first quarter 2009, but not received until the middle of April 2009. We consider the temporary decline in cash of $1,017,000 a normal part of the payment and receipt cycle. We believe we will end 2009 with at least as much cash as we ended 2008 and we continue to manage our overall cash flow in an effort to achieve breakeven or positive cash flow. We believe a significant portion of our spending is discretionary and flexible and that we have the ability to adjust overall cash spending to react, as needed, to any shortfalls in projected cash. Impact of Current Economic Crisis
Multiple events during 2008 involving the financial sector of the global economy have effectively restricted current liquidity within the capital markets throughout the U.S. and around the world. Despite efforts by U.S. treasury and banking regulators to provide liquidity to the financial sector, capital markets continue to remain constrained and volatile. We expect access to the capital markets to be restricted throughout 2009 and possibly longer should capital markets remain dysfunctional.

   Sources and Uses of Cash Summary

                                                                     Three Months Ended March 31,
                                                                       2009                  2008
Net cash (used in) provided by operations                         $     (876,000 )       $    257,000
. . .