"objective," and other similar expressions. Such forward-looking statements may be contained in the "Management Discussion and Analysis" section below, among other places.
Although we believe that the expectations reflected in any of our forward-looking statements are reasonable, actual results could differ materially from those projected or assumed in any of our forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to change and to inherent risks and uncertainties, such as those in this document and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008. We do not intend, and undertake no obligation, to update or revise any forward-looking statement, except as required by federal securities regulations. 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. Specific to our e-Prescribing business, we announced on June 11, 2009, that we had retained Allen & Company LLC to assist our Board of Directors in investigating strategic alternatives ("Strategic Alternatives Review") for maximizing value of this business segment. Refer to the section labeled, "Results of Operations" - "Revenue Indicators - Backlog, Orders, and Deployments" below for more information with respect to the Strategic Alternatives Review.
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 and operates 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 Annual Report on Form 10-K, for the year ended December 31, 2008. We discuss our Critical Accounting Policies and Estimates in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2008.
Results of Operations
Third Quarter 2009 Summary of Operations Financial
• Revenue for the quarter ended September 30, 2009, was $7,835,000 compared with $6,709,000 for the same period in 2008 representing a 17% increase.

• Gross profit for the quarter ended September 30, 2009, was $5,586,000 or 71% of revenues compared with $4,326,000 or 64% of revenues for the comparable period in 2008.

Email Encryption - gross profit was $5,506,000 or 82% of revenues compared with $4,593,000 or 82% of revenues for the comparable period in 2008. e-Prescribing - gross profit was $80,000 or 7% of revenues compared with gross loss of $267,000 or 24% of revenues for the comparable period in 2008.

• Net loss for the quarter ended September 30, 2009, was $657,000 compared with a net loss of $1,509,000 in 2008. Included in the loss for the quarter ended September 30, 2009, was approximately $300,000 of non-recurring severance costs and non-recurring expenses related to the Strategic Alternatives Review as well as a non-recurring stock based compensation expense of approximately $482,000 associated with the Company's stock option system conversion.

• Ending cash and cash equivalents were $12,392,000 on September 30, 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 September 30, 2009, were $1,314,000 and customer contract renewals were 91% on a contract value basis. The renewal rate of 91%, although lower than our historical rate of 93% to 95%, reflected an improvement from the 86% achieved in the preceding quarter. The factors driving the non-renewal generally fell into two categories: impact of the economy or competition. Consistent with the first half of the year, the economy has in many cases resulted in reduced IT budgets forcing customers either to cut back on the number of users or services they purchased or decide to do without an email encryption solution altogether. In other cases, competition was the primary driver which manifested itself either through lower prices or a desire to purchase bundled solutions that included anti-spam and anti-virus services.

• We deployed approximately 210 new e-Prescribing devices to prescribers and reached approximately 2.3 million electronic prescriptions transacted in the three-month period ended September 30, 2009 (the $2.3 million was 16% higher than the same period in 2008).

• During the third quarter of 2009, the Company received cash proceeds totaling approximately $339,000 from the exercise of 207,561 warrants.

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

                                                                                   3-month Variance                                                              9-month Variance
                                  Three Months Ended September 30,                   2009 vs. 2008                 Nine Months Ended September 30,                 2009 vs. 2008
                                   2009                     2008                   $                %                 2009                  2008                 $                %
Email Encryption             $       6,685,000        $       5,578,000       $  1,107,000             20 %     $     19,306,000        $  16,534,000       $  2,772,000             17 %
e-Prescribing                        1,150,000                1,131,000             19,000              2 %            3,156,000            4,332,000         (1,176,000 )          (27 %)

Total revenues               $       7,835,000        $       6,709,000       $  1,126,000             17 %     $     22,462,000        $  20,866,000       $  1,596,000              8 %

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 slight increase in e-Prescribing revenue in the three months ended September 30, 2009, versus the same period in 2008 was driven primarily by: (i) an increase in transaction fees related to a retroactive contract extension in one customer program; and (ii) an increase in renewal related revenue. These increases were offset by a decline in deployment and other revenue. Relative to the nine-month comparison, the decline in revenue was also due largely to (i) a decrease in deployment related revenue, including a first quarter 2008 one-time revenue catch-up upon reaching certain required deployment-related metrics for a single customer contract, as well as
(ii) a drop in transaction fee revenue after reaching a contractual cap in one customer program. These decreases were slightly offset by an increase in renewal related revenue.
Revenue Indicators - Backlog, Orders and Deployments Company-wide backlog - Our end-user order backlog totals $40,980,000 and is comprised of contractually bound agreements that we expect to fully amortize into revenue. As of September 30, 2009, the backlog was comprised of the following elements: $17,186,000 of deferred revenue that has been billed and paid, $4,208,000 billed but unpaid, and approximately $19,586,000 of unbilled contracts. The total backlog distributed by segment was $38,974,000 for Email Encryption and $2,006,000 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 approximately $6,500,000 and $5,200,000 for the three-month periods ended September 30, 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 $1,314,000 and $1,170,000 for the three months ended September 30, 2009 and 2008, respectively. About half of our new orders were from the healthcare sector reflecting a growing emphasis on security and privacy for healthcare and specifically patient medical information. Regulatory compliance with specific measures including the expansion of HIPAA in the American Recovery and Reinvestment Act and new state laws continued to fuel strong demand for our services from new customers.
e-Prescribing - On June 11, 2009, we announced that we retained Allen & Company LLC to assist our Board of Directors in investigating strategic alternatives for maximizing the value of the Company's e-Prescribing business. We are looking at options to maximize the value of this business asset, ranging from ongoing involvement in the industry through a partnership or joint venture where we capitalize on our core competency to host prescription processing to completely exiting this business through a divestiture or shutdown.
While evaluating these options, we continue to execute on our existing contracts and to provide services to our customers. We have also evaluated how we operate this business and have determined to switch to a lower-touch (i.e., lower-cost model). As part of our transition to this lower-touch, lower-cost model, we have reduced a number of positions and taken other cost cutting measures. By incorporating more remote selling, deploying and training (i.e., lower-touch model), we expect to be able to recruit and deploy with fewer resources. Consistent with this approach, we reduced 12 positions in the third quarter and another 14 positions in October 2009, primarily associated with the e-Prescribing line of business. We incurred severance costs of approximately $200,000 in the third quarter and expect to incur approximately $400,000 in the fourth quarter of this year. Although not solely related to the e-Prescribing business, previously, in the second quarter of this year, we had reduced 12 positions resulting in severance cost of approximately $500,000. We have 24 remaining employees now dedicated to the e-Prescribing business following these reductions. This compares to 73 employees assigned to the e-Prescribing business at December 31, 2008. In addition to the reductions discussed above, any further reductions were the result of attrition or reassignment.
We had approximately 190 sponsored, but not-yet-deployed prescribers in our backlog at September 30, 2009. 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 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.
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 75% to 80% of deployed prescribers have become active users. Year to date, the licensed attrition rate, excluding new deployments is approximately 23%. As of September 30, 2009, approximately 3,080 active prescribers were using our service, compared to approximately 3,130 at September 30, 2008. The decrease in the number of active prescribers resulted from attrition occurring in both the ordinary course of business, and from the loss of active users associated with one clinic. This clinic accounted for approximately 15% of our total active prescribers, and previously notified us that they would discontinue our e-Prescribing Service in 2009 as they completed their migration to a full electronic medical record solution. Of the remaining 310 active prescribers associated with this clinic, we expect to see further attrition to our number of active prescribers as this clinic continues in its migration process. 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 $227,000 in total transaction and usage-based fees revenue in the quarter ended September 30, 2009, compared to $170,000 in the same period 2008. This increase in transaction fees is related to a retroactive contract extension in a single payor contract. The Company currently earns transaction-based fees (or the equivalent) with three health care payors. We continue to pursue revenue opportunities from transaction fees from existing customers. Also, 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 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 7.4 million prescriptions transacted in the first nine months of 2009 versus approximately 6.4 million prescriptions in the comparable 2008 period.
Recently enacted national healthcare legislation indicates interest on the part of the nation's lawmakers toward improving the healthcare system. Beginning with the Medicare Improvements for Patients and Providers Act of 2008 ("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, 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. However, the specific requirements for EHR solutions which will be eligible for Federal subsidized incentives are still being defined by the Federal Government which could introduce uncertainty relative to the solutions. Accordingly, as healthcare technologies' role in the improvement of the nation's healthcare system continues to evolve, we are addressing through the Strategic Alternatives Review the time required and risk associated with the continued investment in this business. As we continue to evaluate all aspects of our e-Prescribing business and the best ways to capitalize on upcoming developments, we are looking at options to maximize the value of this business asset, ranging from ongoing involvement in the industry through partnership or joint venture to completely exiting this business through divestiture. Cost of Revenues
The following table sets forth a period-over-period comparison of the cost of revenues by product line.

                                Three Months Ended                 3-month Variance                                                                9-month Variance
                                   September 30,                     2009 vs. 2008                  Nine Months Ended September 30,                  2009 vs. 2008
                              2009              2008                $               %                 2009                    2008                  $               %
Email Encryption           $ 1,179,000       $   985,000       $   194,000            20 %      $      3,280,000        $      3,094,000       $   186,000             6 %
e-Prescribing                1,070,000         1,398,000          (328,000 )         (23 %)            3,808,000               4,411,000          (603,000 )         (14 %)

Total cost of revenues     $ 2,249,000       $ 2,383,000       $  (134,000 )          (6 %)     $      7,088,000        $      7,505,000       $  (417,000 )          (6 %)

The cost of revenues improvement for the three-month period ended September 30, 2009, versus the three-month period ended September 30, 2008, resulted primarily from (i) a $190,000 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 $11,000 decrease in other non-people costs primarily associated with decreased deployments and recruitments of our e-Prescribing product, partially offset by an increase of $67,000 in stock-based compensation expense. The cost of revenues improvement for the nine months ended September 30, 2009, compared to the same period in 2008, resulted primarily from a $531,000 decrease in salary and benefits for individuals performing deployment activities due to a decrease in average headcount, primarily in the e-Prescribing product line, partially offset by increased 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, field prescriber recruiting , field deployment, customer service and support and e-Prescribing device costs. In e-Prescribing, a greater proportion of total cost of revenues relates to prescriber recruiting, 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 cost of revenues.
As discussed above, the Company is pursuing a lower-touch, lower-cost approach to operating the e-Prescribing business and accordingly, we reduced four deployment related positions associated with our e-Prescribing business in the third quarter.
Research and Development Expenses
The following table sets forth a period-over-period comparison of our research and development expenses:

Three Months Ended 3-month Variance 9-month Variance September 30, 2009 vs. 2008 Nine Months Ended September 30, 2009 vs. 2008 2009 2008 $ % 2009 2008 $ % Research and development $ 1,760,000 $ 1,590,000 $ 170,000 11 % $ 5,238,000 $ 4,516,000 $ 722,000 16 %

Research and development expenses consist primarily of salary, benefits, and stock-based compensation for our development staff, and non-people costs associated with enhancing our existing products and services and developing new products and services. The increase in research and development expense for the three-month period ended September 30, 2009, compared to the same period in 2008 was primarily attributable to (i) a $106,000 increase in salary and benefit expense resulting from an increase in average headcount and salary increases involving both product lines, and (ii) a $66,000 increase in stock-based compensation expense, partially offset by decreases in various other non-people expenses associated with research and development activities.
The increase in research and development expense for the nine-month period ended September 30, 2009, compared to the same period in 2008 was primarily attributable to (i) a $616,000 increase in salary and benefit expense resulting from an increase in average headcount and salary increases involving both product lines, (ii) an $86,000 increase in stock-based compensation expense, and
(iii) a $20,000 increase in IT services, plus other increases in various other non-people expenses associated with research and development activities. The three and nine-month periods ended September 30, 2008, benefited from a one-time cost of revenue deferral of approximately $50,000 and $200,000 respectively, specific to an e-Prescribing customer contract. New development activities in Email Encryption were related to design improvements to reduce special customer network configurations related to VPM deployment and improve rate and capacity of deployments for hosted ZixVPM, ZixPort and ZixDirect services. We also launched significant work to enable multi-language flexibility in a number of systems. In the e-Prescribing R&D area, we added flexibility to the controlled substance prescribing process and began initial work on proposed system improvements related to new CCHIT/ARRA meaningful use requirements.
Selling, General and Administrative Expenses The following table sets forth a period-over-period comparison of our selling, general and administrative expenses:

Three Months Ended 3-month Variance 9-month Variance September 30, 2009 vs. 2008 Nine Months Ended September 30, 2009 vs. 2008 2009 2008 $ % 2009 2008 $ % Selling, general and
administrative $ 4,557,000 $ 4,232,000 $ 325,000 8 % $ 14,429,000 $ 13,656,000 $ 773,000 6 %

Selling, general and administrative expenses ("SG&A") consist primarily of salary, stock-based compensation and benefit costs for marketing, selling, executive and administrative personnel as well as costs associated with promotions, professional services and general corporate activities. The increase in SG&A expenses in the third quarter of 2009 compared to the same quarter in 2008 reflected (i) a $186,000 increase in salary and benefit expenses due to non-recurring severance costs, (ii) a $160,000 increase resulting primarily from professional services cost related to shifting legal work to outside counsel, and (iii) a $313,000 increase in stock-based compensation expense largely offset by a decrease in salary and benefit costs of $294,000 due to lower average headcount and other decreases across several spending categories including consulting, marketing, and travel expenses.
During the third quarter the Company converted to a new third party stock option system which spreads ratably the expense related to stock option forfeitures over each quarter of the vesting period compared to our legacy system that deferred the forfeitures until option grants were fully vested. Although both the new and the legacy systems record the same expense over the life of fully vested stock options, the timing difference created by the two different systems required that we align the two systems upon conversion. In the third quarter our SFAS123R expense includes a non-recurring, non-cash "true-up" of $482,000 in stock-based compensation expense which was the amount of the forfeiture expense related to vesting options previously deferred in the legacy system most of which was included in SG&A expenses. . . .