Zix Corporation
Q2 2008 Earnings Call Transcript

Published: 20 Aug 2008

[Operator:]

Welcome to the second quarter 2008 Zix Corporation earnings conference call. (Operator's instruction) I will now like to turn the call over to Peter Wilensky, Vice President of Corporate Development and Corporate Affairs.

[Peter Wilensky:]

This call is being recorded and a replay will be available after the call's conclusion from our website or by dialing 1-888-286-8010 and entering the access code 34586302. This information can also be found at investor.zixcorp.com which is the investors' portion of our website. ZixCorp's chief executive officer, Rick Spurr, will begin with an overview of the company and the discussion of our businesses followed by discussion of the Q2 financial results by our chief financial officer, Barry Wilson. Mr. Spurr will then provide closing remarks. Afterwards, we will be available to answer questions from analysts and institutional investors and we will also be taking questions by email which can be sent to our investor relations mailbox, [e-mail]. Before we begin, I would like to read a paragraph regarding any forward-looking statements that may be made during this call. This conference call may include certain forward-looking statements that are based on the current belief or assumptions made by or information currently available to ZixCorp's management team. Forward-looking statements may include words such as anticipate, believe, estimate, expect, may, project, will, could, should or other similar expressions. ZixCorp's actual results, performance, prospects or opportunities in 2008 and beyond could differ materially from those expressed in or implied by these statements. Information concerning risk factors that could allow actual results to differ materially from those expressed in or implied by these forward-looking statements is contained in ZixCorp's filings with the Securities and Exchange Commission as well as in ZixCorp's earnings press release issued earlier today. Except as required by federal securities regulations, ZixCorp undertakes no obligation to publicly update or revise any forward-looking statement for any reason after the date of this call. With that, I am pleased to turn the call over to Rick Spurr.

[Richard Spurr:]

Transformation is a common trend now running through both the Company and the markets in which we compete. Today I will describe the transformations taking place in our two markets and describe why we think ZixCorp is remarkably well positioned as a leader in each core business and poised for what we believe will be outstanding success. Those of you who have followed the Company know that we have been intensely focused on transforming your Company from an early stage enterprise consuming cash to one with solid fundamentals producing cash. We continue to strengthen our financial foundation to enhance our platform for growth and as evidence, I am proud to report that in Q2, we achieved our second quarter of positive cash flow from operations. Our Email Encryption business has been the source of the Company's cash, generating enough cash flow to cover its own costs, all of the corporate overheads and also contribute about $2 million per quarter to our e-Prescribing business. The margins in the email business continued to improve with another record in gross margin at 81% which given our flat R&D and sales and marketing spending means improving operating margins for this business as well before G&A allocations. So, I feel very good about where the Email business is today and very good about its future prospects for accelerated growth. We believe that irrespective of the e-Prescribing business, Email Encryption will continue to drive the financial transformation of the Company. The Email Encryption market and perhaps the entire enterprise software industry is also undergoing a transformation with the growing recognition of the superiority of the software as a service or a SaaS model for ensuring reliability, integrity, scalability and security while at the same time reducing costs and increasing speed to market. The SaaS philosophy is being perpetuated by the likes of Google, Microsoft, IBM, Yahoo, Amazon and others. More and more companies are coming to the realization that building and maintaining their own infrastructures for essential IT applications just does not make sense. This view is particularly relative during today's weak macro economic environment which should be yet another driver for a continued shift towards SaaS. The industry analyst firm Gartner has identified security as a service, sometimes referred to as Security-in-the-Cloud as the fastest growing segment within the enterprise security space. In predictions, by the year 2013, 70% of this market will be offered as a service. In this context, we believe that the days of traditional enterprise sales are numbered and that organizations will no longer tolerate the antiquated practice of purchasing software that they have to implement, monitor and maintain and will instead opt for a service base approach where they can outsource all of these responsibilities in exchange for a fix subscription fee. I believe that is one of the main reasons why SaaS companies are commanding a premium valuation in the stock market. So, as a SaaS Company with highly recurring and predictable revenue and is the only significant provider of encryption services using this model, we believe we had emerged as the vendor and partner of choice for Security-in-the-Cloud or Security-as-a-Service offerings, again the fastest growing segment of the security market according to Gartner. Not only have we emerged as the leader in this market but we have also done so with a highly differentiated and defensible approach which is the SaaS model combined with our sharable directory of users which we called the Zix Directory. We recently reported that this Zix Directory now has over 11 million shared identities used for encryption and is growing in over 70,000 per week. Let us continue to talk numbers. In the second quarter, we had near record total orders for our email encryption service of 8.4 million including 1.4 million of new first year orders for the six consecutive quarters. Keep in mind that in a subscription model with strong renewal rates, new sales represent incremental cash and revenue so this level of new orders translates into healthy growth and can be seen by the 38% year-on-year increase in revenues. This sustained level of new first year orders reflects another positive aspect of this business which is that we remain largely insolated from the current economic downturn because compliance and the need to protect confidential information continue in tough economic times while the threats to email security are only increasing. With regard to renewals, as we disclosed in the CEO update issued earlier this month and reiterated in the earnings release issued earlier today, we had one customer cancellation in 2Q which alone represented 7% of the renewal base. This large hospital group made this decision as part of a technology consolidation where they transitioned 17 district data centers into one centralized scheme and a competitor of ours, pursuing a very large comprehensive infrastructure software contract, was able to include email encryption at a substantially reduced price. The customer indicated that they were very happy with our Email Encryption service; cost became the primary consideration in this decision. This 7% of the renewal base represented about $200,000. On the positive side with our overall renewal rate still at an impressive 93%, we renewed essentially 100% of the rest of the base measured on a revenue basis. So, the bottom line is that we are not seeing a new trend at this point to cause us concern regarding our renewal rates. Overall revenue growth continues again at 38% year-on-year. We remained the dominant Email Encryption provider in healthcare with 30 clients including WellPoint, Cigna, Humana and over 1,000 hospitals and we are continuing to build on our strong foothold in the financial services sector. We added over 80 new financial institutions in Q2 to bring our total to more than 700 and we now have finance customers in each of the 50 states and in Washington, DC. On the government front, we have 20 state banking regulators as customers in addition to all of the federal banking regulators and we also have customers in 15 state governments and 37 county agencies. So, our footprint is expanding yet there is still significant room for growth particularly in the financial sector where our 700 customers represent only 4% of the US market and in state local government where our initial penetration represents still a very small percentage of the potential and that is just in the United States. As part of what has been our long term strategy, we are also beginning to penetrate global markets through our partners and have landed our first meaningful contracts in the UK, obviously one of the global financial centers outside the United States. These OEM partners are expected to be one of the primary avenues for realizing growth. As we have discussed previously, we launched our OEM channel program in August in 2006 and are now starting to see more meaningful results from that effort. We have Postini and Google, Secure Works and most recently Message Labs. We have the major message security services providers in the industry. IBC estimated that just pre acquisition Postini and message labs together had over 50% of the message security services market which, as I mentioned earlier, is expected to become the dominant method to market in this industry. So, we have aligned ourselves with the leading companies and the fastest growing segment in the industry. As the industry transformation continues toward the SaaS model, as the only significant hosted Email Encryption provider, we are well positioned to remain the partner of choice with these hosted services vendors. In addition to these partners, we previously announced that we had signed with a brand name manufacturer that is preparing to launch a new hosted service and offer our Email Encryption service as part of their solution but we still cannot yet disclose the name until this new service is launched. Recently, a leading US Telco began white labeling our service under their brand as part of their new message security offering. So, we had a number of potentially significant partners we are working with that we anticipate will become a meaningful source of business for the Company and the results are starting to support that expectation. Through the first six months of 2008, we have already exceeded the business brought in from these channels for all of 2007. We have previously indicated that we did not expect to see a significant contribution from some of the more recently launched programs until Q3 to current quarter and I was specifically referring to Google's message encryption service launched in February. In fact, we are expecting to see substantial growth from the channels in Q3 relative to the first two quarters of this year and look to next year for additional growth as these other just signed partners begin to ramp up. So, we are in the midst of major industry transformation in the message security space that plays into our position as the only significant SaaS provider of Email Encryption while our other core business e-Prescribing is also undergoing a significant transformation. Of course I am speaking of the Medicare Improvements for Patients and Providers Act of 2008 that became law exactly two weeks ago today which provides Medicare funded financial incentives for the adoption and utilization of e-Prescribing. As many of you know I spoke at some length on a conference call two days after the law was passed to share our perspective on the impact of this legislation and that replay is still available if you are interested. Today, I will touch on the highlights of that call. This law represents the first time that Medicare is using its best purchasing power to drive the widespread adoption of clinical information technology and can be an important catalyst in bringing our healthcare system into the 21st century. With 1.5 million people each year injured from medication errors including 7000 deaths, the need for modernizing the delivery of care in this country has never been clearer. I believe that this legislation is a defining moment for the e-Prescribing industry because Medicare is the largest payer in the country and to the majority of doctors seeing Medicare patients. So, technologies adopted for Medicare tend to be used in the general practice of medicine. This is a unique point in history where we have legislation with financial incentives to promote the widespread adoption of technology. The law structured to provide a 2% bonus on allowable Medicare fees starting in 2009 and declining overtime to be replaced with a penalty that grows to 2% by 2014. Current estimates are that 2% could represent $2,000 to $4,000 per doctor per year which should provide a sufficient incentive to change behavior and as pressure mounts from the employers and the patients, we expect that at some point, e-Prescribing simply becomes the standard of care. When discussing ZixCorp's e-Prescribing business, there are three keys necessary to understand our strategy. Number one, we are standalone e-Prescribing vendor. Number two, we focus on primary care docs who practice in small groups and three, payers or health plans underwrite to deployment of our technology for doctors. I will touch briefly on each key. First of all, we are a best of breed standalone e-Prescribing vendor as opposed to providing e-Prescribing capabilities within electronic medical record or EMR application. The importance of this distinction pertains to time, cost and resources required for the doctor as well as the competitive landscape. First of all as it relates to time, costs and resources for the doctor. For an EMR, the cost can be as high as $30,000 to $35,000 per doctor to implement. It can take 12 to 18 months to get going and is typically an on-premise application that needs to be managed. In contrast, our standalone e-Prescribing application lists for only $2000 for the first year. It can be installed in a matter of weeks and is offered in a SaaS model so we handle all the maintenance and support. So, cheaper, faster and easier to implement and maintain while providing best of breed capabilities is understandably attractive to many doctors and to our payer customers. Secondly as it relates to the competitive landscape; there are countless EMR vendors including the very largest HIT vendors, GE, McKesson and Allscripts to name only a few. In contrast, there are only two standalone e-Prescribing vendors with any meaningful market share, Zix and Dr. First. A third might be Allscripts but they refuse to report or even share in investor presentations actual standalone e-Prescribing usage. Unlike some competitors in this space, we have the engineering know-how to stay on the leading edge on this industry. As the bar gets raised higher this year with more stringent certification requirements from necessary industry partners such as SureScripts-RxHub, the required complex application and work flow design becomes more of a barrier to entry for newcomers and even raises the table stakes for current industry participants to continue in this market. We are on top of this technologically complex process and on track to achieve new certifications which is important as these certifications become an important criteria for participating in new programs. The second key point in our strategy is that we focus on primary care physicians in practices of five or fewer. We focus on this primary care physicians because they tend to be the highest prescribers and we focus on practices of five or less because they represent 75% of the market. According to government data, primary care practices of five doctors or fewer represent about 100,000 doctors. This is our initial target market. These practices are small businesses focused on paying their bills and running the business and do not have time or resources to implement large IT systems. So, cheaper, faster and easier to implement and maintain goes from just being attractive to being a necessity. The data supports this. Recent New England Journal of Medicine surveys found that only 9% of doctors practicing in groups of three or fewer have adopted an EMR versus 51% of practices with 50 or more doctors. So, our product strategy get started with easy to implement standalone e-Prescribing and our target market to 75% of the market represented by small practices go hand in hand. The final key to our strategy is Payor funding. Physicians have been historically unwilling to pay for technology even at what might be considered a reasonable price so we pioneered the strategy of having the payer underwrite the entire first year including all the setup cost. The payer's fund these initiatives because they derive the majority of economic incentives from the use of lower cost drugs and help your patients avoiding hospital visits and the other impacts from adverse drug events or ADEs. By the way, on this last point regarding ADEs, we expect information on the economic impact of this patient safety feature to be made public very soon. Payers are also funding these programs because in many cases, they see this as an opportunity to establish a real time connection with the doctor for strategic value. Our strategy Payor funding is also a scalable method for deploying e-Prescribing to thousands of physicians quickly. Because the payers do not see any of these benefits if the doctors are not using the application, they also add an incentive to accelerate the adoption of this technology. But our five years of experience in this market shows that just having e-Prescribing available at no cost is not sufficient to ensure uptake. Therefore we have created a high touch turnkey solution funded by the payers to guide the physician through the process and handle all of the administrative hassles of getting the system up and running. We have found that loading the patient data into the system, configuring the hardware including mobile devices and providing on-site training are just some of the steps necessary to get successful adoption of e-Prescribing. This is why we do not believe that other competitive systems like NEPSI that just put some information on a website for the doctor to download and install him self or her self, these will not be successful on a large scale. So, in summary the three keys necessary to understand our strategy. Number one, we are a standalone e-Prescribing vendor, number two, we focus on primary care docs who practice in small groups and three, and payers underwrite the deployment of our technology for doctors. We believe the strategy is the right one for e-Prescribing market leadership, if not dominance and now, with the endorsement of standalone e-Prescribing and financial incentives in the new Medicare Improvements for Patients and Providers Act of 2008, we expect acceleration of the overall e-Prescribing market. In fact, CMS recently announced that they will hold a conference in the fall in part to service a bully pulpit to promote the adoption of e-Prescribing. We expect to see immediately improvements in our business in terms of recruiting success, conversion to active prescribers and retention. We are already receiving inbound inquiries from physicians looking to implement an e-Prescribing system over the next few months either in reaction to new payer sponsored, P4P programs, or so that they will be ready come January 1 for the Medicare incentives because any delay in adoption means lost revenue opportunities for the doc that are gone forever. Lastly, we expect the legislation will serve as a catalyst for payer sponsorships. Why, because it is the right thing to do to improve patients' safety, to lower the cost of healthcare and to establish a real time electronic connection with the doctor. Now, the legislation provides further incentives from Medicare to accelerate e-Prescribing usage and the law also provides payers a one time opportunity to step up and assist physicians with the potential cash flow issue due to the timing discrepancy between the upfront cost of installing the technology and receiving the bonus on the backend. Good provider relations are important to healthcare payers so the potential goodwill from providing such assistance is very valuable. So, we are presenting with unique point in time in the transformation of this industry. The buzz surrounding the passage of the law has raised to new heights an awareness of the benefits of the need for e-Prescribing. The declining financial incentives in the legislation mean that any delay represents a lost revenue opportunity and ultimately a penalty overtime. I believe the next 12 to 18 months will be quite dynamic in this industry. ZixCorp has an established track record with documented proven results and tremendous success in the adoption and utilization of e-Prescribing especially in the smaller practices that comprised the majority of the physician market. The Zix brand is very well known in the payers' space and by physicians in markets we serve. ZixCorp is therefore well positioned to enhance its leadership position in this market while at the same time continuing to build a strategic asset with the platform for delivering real time patient's specific information to the point of care. With that, I will turn the call over to our CFO, Barry Wilson for a more detailed discussion of Q2's financial results.

[Barry Wilson:]

There are four significant areas of the business that I will discuss today. One is revenues, the achieved Company-wide revenues is $7 million which was at the top of our previously projected guidance of $6.7 million to $7 million. Company wide, this represents an increase of 25% over Q2 of 2007 and for Email Encryption; this represents an increase of 38% over Q2 of 2007. The second area of business is gross margin; our Company wide gross margin for Q2 is 63% of revenues which is comparable to the 52% for Q2 2007. For Email Encryption, our gross margin was 81% for the quarter. Third area of the business is expenses; operating expenses for this quarter remain relatively flat when compared to Q2 of 2007. Fourth area is cash flow; the company had a positive cash flow in Q2 of approximately $422,000, this compares to $350,000 cash burn in Q2 of 2007. For the first six months of 2008, our positive cash flow was $749,000. Our quarter-end total cash of $13 million exceeded our previous guidance of $12.6 million to $12.9 million. Now, let us take a closer review of the financial details beginning with revenues. Company-wide revenue of $7 million for the quarter was up $1.4 million or 25% over the $5.6 million for the same quarter in 2007. The $7 million total was comprised of $5.7 million for Email Encryption and $1.3 million for e-Prescribing. The $1.4 million increase was comprised of a $1.5 million increase for Email Encryption which was offset by $100,000 decrease for e-Prescribing. The $1.5 million Email Encryption increase represents the 38% increase over the comparable 2007 figure. The Email Encryption revenue increase is driven by the Company's continual addition of new subscribers to the subscriber base while at the same time, renewing a higher percentage of existing subscribers whose subscriptions are due for renewal. The e-Prescribing revenue for this quarter was $1.3 million which compares to $1.9 million for Q1 2008, representing an approximate decrease of 32%. This decrease primarily resulted from the following; one, we experience the decline in transaction usage base fees because we had reached the ceiling or cap on the transaction usage fees allowed under a contract with a single healthcare pair customer. Two, Q1 2008 included a nonrecurring revenue item of $350,000 and three; there were no significant new prescriber deployments in the quarter. For Q3, we foresee a decrease in e-Prescribing revenues in light of the slowdown available to deployments during the past two quarters and the recent decline in transaction and usage base fees. Company ends Q2 of 2008 with bookings backlog of $37 million or a 24% increase or the bookings backlog of $29.9 million at the end of Q2 of 2007. In sum, we are pleased with the quarterly year-on-year growth in revenues for Email Encryption of 38% and patient, with respect to e-Prescribing given that it is still under the market. Now let us take closer review at the gross margin financial details. We achieved an overall Company-wide gross margin of $4.4 million or 63% of revenues, this compares to $2.9 million or 52% of revenues in Q2 of 2007. The Email Encryption gross margin in the second quarter was $4.6 million or 81% of revenue. This compares to a margin of $3.1 million or 75% in Q2 of 2007. The improvement was due approximately to a $1.5 million increase in revenues with little changing cost. These improvements are a natural consequence of our subscription business model relative with fix cost structure. We add to the Email Encryption customer base and retain existing customers via a high level of customer renewals while maintaining a relatively flat cost structure. For e-Prescribing, the gross margin in Q2 of 2008 was a negative $200,000 or 15% of revenues. This occurred because of our e-Prescribing costs that remain relatively constant while revenue has decreased from the reasons discussed earlier. Let us now review operating expenses. Operating expenses inclusive of R&D and SG&A expenses were relatively flat between Q2 of 2008 which were $6 million and Q2 of 2007 which were $6.1 million. Turning to cash flow, we are pleased with positive Q2 cash flow of $422,000, this compares to a cash burn of $350,000 for Q2 of 2007. We are also pleased with our Q2 2008 quarter end in cash position of $13 million. The bottom line, so to speak, for Q2 2008 from all of these activities netted to a Company-wide net loss of $1.4 million compared to a $3.1 million net loss for the same period in 2007. The year-to-date 2008 loss was $3.1 million which compares to a $4.8 million loss for the same period in 2007 which included several nonrecurring items totaling $1.7 million in gains. Now, I would like to turn the call back over to Rick.

[Richard Spurr:]

I will conclude with guidance and a few closing remarks. We are projecting revenue for Q3 to be between $6.6 million and $7 million. This total reflects growth in Email Encryption and a decline in e-Prescribing. As indicated in previous conference calls, our e-Prescribing revenues will remain depressed until we contract for new deployments and increase the current run rate. E-Prescribing deployments for Q3 are expected to be again around a hundred. Our cash in Q3 is expected to exceed to $13 million ending cash balance from Q2. With respect to new sources for deployments, we did announce that we were participating L.A. Care's Health IT Incentive Program but given that it is a different kind of contractual structure for us, it is still too early to say how many deployments we will achieve there. Highmark recently announced funding for a $29 million multi-vendor program for e-Prescribing and EMRs. We are working closely with them as they define the parameters for participation and we expect to be part of that program when it launches later this summer or in the early fall. This level of funding is exceptional providing 75% of a prescribers first year costs. Combined with the Medicare funding, this program should provide sufficient subsidies to offset all first year costs for a high touch turnkey approach which is our specialty in the Pennsylvania marketplace. With the exception of Blue Cross and Blue Shield of North Carolina, our payer customers are digesting, I should say with the exception of them, all of our payer customers are digesting the passage of the Medicare law and continued to go through their processes to evaluate their programs and any decision to expand. A couple of the larger plans have documented very impressive cost savings and clearly understand the strategic value of electronic platform with their very valuable asset to docs. Right now, they are discussing various program structures with the aim of capitalizing on the current momentum created by the largest payer in the country endorsing and providing incentives for e-Prescribing. They are evaluating these various funding models for an acceptable investment, cash flow and return. Unfortunately at this point, I cannot comment any further on the status of these discussions other than to say that because of the new Medicare law and its financial incentives for e-Prescribing, I do remain confident that this industry is entering a new era of accelerated activity and that we remain well positioned to succeed in this environment. When I look at the respect our brand has in the e-Prescribing industry, combined with the strong position we have in Email Encryption, I believe we are poised for exceptional growth and success. Thank you again for your attention today and we will now turn the call over to the operator for any questions.

[Operator:]

(Operator's instruction) Your first question comes from the line of Jonathan Ruykhaver.

[Jonathan Ruykhaver:]

So, actually on e-Prescribing, what was the number of subscribers that you had, actually, in the quarter?

[Richard Spurr:]

140, I think. Right, guys?

[Jonathan Ruykhaver:]

One hundred and forty, that sum you added in the quarter?

[Richard Spurr:]

Those were new deployments, 140 new deployments. The quarter was flat because of attrition. So, a hundred and forty is above replacement number.

[Jonathan Ruykhaver:]

Okay, so how many active doctors did you have at the end of that period?

[Richard Spurr:]

It is around 3300 which is what we had last quarter.

[Jonathan Ruykhaver:]

Okay, 3300 and then I think you said to expect a hundred docs to tying up in the current quarter, is that right?

[Richard Spurr:]

Once again we will say we think we will deploy around a hundred docs.

[Jonathan Ruykhaver:]

Okay, is it still your assumption that you can get 1200 per doc per year?

[Richard Spurr:]

Yes. That is still our financial model and we have not seen anything to…

[Jonathan Ruykhaver:]

So, the decline in transaction usage space fees and the deployment related fees that does not imply that you need to get to a greater doc number that you suggested in the past to get to breakeven on that business?

[Richard Spurr:]

Yes, so the deployments again are only relevant in year one and our business model at the 1200 recorded is our target for top line revenue in years two and beyond. So, that part of the model really is not affected by the rate of deployments. Obviously the timeframe for us getting the breakeven is affected by the rate of deployments. There has been a decline in transaction-based revenues as we recap on one of our shared savings contracts with one customer but that single event has not processed to modify your expectation about top line overtime.

[Jonathan Ruykhaver:]

Is it safe to say that you just do not yet have real visibility in terms of ramp on the doc side because the payers are going through how they are going to approach this new legislation and it is probably going to be late this year, early next year before we start to have better visibility into that ramp?

[Richard Spurr:]

Yes, that is exactly right and I cannot say whether it is late this year or early next year but there is lots of discussion and we just do not have clear visibility, as you say, into that ramp.

[Jonathan Ruykhaver:]

And I guess that same potential opportunity, are there any constraints on your side in the event payers really push the fund to the doctors as they are going to pay for the cost on the startup side, you have to go into a doc office with your field organization, you are going to do a site survey, you have to put in the bandwidth, you have to load the patient data and train the doc? Do you have the field staff, the field support organization to really ramp those docs if the demand really is there or is that capacity something you need to build out within the organization?

[Richard Spurr:]

So, let me address the scale organization sort of in the broader text. We have invested in the systems architecture so that the backend systems are, as my engineering team tells me, infinitely scalable so that work is already been done. There is the, as you suggest feet on the street to actually go do the recruiting of the physicians and then secondarily the technical deployment and training stuff and our current staffs are not sufficient to scale into the thousands. So, you can do the math, it takes one recruiter to recruit around a hundred doctors in a quarter. So, take your standard salary and added fees for travel and such and that gets divided into a hundred docs so we can add if we did, so by at math, we have got the capacity to do about 500 docs now. If we have to go 3500, we have to add, say 30 people, if we want to go to 3500 per quarter, I am just posting the numbers on it, and we got to add 30 guys to that sales team, guys or girls. We have to add a like number at a length of point in time, another quarter thereafter to the technical teams that actually go out and do the deployments and installations. So, that math is if you scale to do 14,000 a year, that is 3500 a quarter, you have to add 30 people.

[Jonathan Ruykhaver:]

So, I guess you do not actually start building that infrastructure ahead of the additions, you wait to see what the payers do and what kind of doctors that actually gets signed up with the payers, right?

[Richard Spurr:]

That is right. When we get the orders and we know the timing of the recruiting and the deployment, then only we go spend the money because these resources are not that difficult to find. The pharmaceutical industry has been leveraging people for a number of years and so the, that is the good source for recruiting people and so it does not take us that long to step up and then on the technical side, the skills are very readily available, many of which we get through the third party contracts.

[Jonathan Ruykhaver:]

Did you guys have a number for the non-stock, non-cash stock comp expense in the quarter?

[Barry Wilson:]

Yes, it is about $450,000, Jonathan.

[Jonathan Ruykhaver:]

$450…where is that allocated? Is that across the goods, R&D and SG&A?

[Barry Wilson:]

Yes, that is allocated across the cost revenues, R&D and SG&A, across both product lines.

[Operator:]

Your next question comes from the line of Jon Hickman from MDB Capital Group.

[Jon Hickman:]

Can you tell how many transactions on the e-Prescribing side occurred this quarter?

[Richard Spurr:]

You are talking about only [scriptioning]?

[Jon Hickman:]

Yes.

[Richard Spurr:]

Peter looks like he is doing a calculation in his head. I do not know, I have to ask him. I mean we can check his math, 2250 divided by 4 times 3300? So, that said that is 550 times 3300.

[Jon Hickman:]

Well, you are just assuming that the third trend of doctors did five first group per week?

[Richard Spurr:]

Well, we know our average docs have continued to write at that rate.

[Jon Hickman:]

Well, I guess the reason I am asking this is last year, you did about 7 million in script, 7.4 some and according to the first quarter number, you are in track to do about 9 million so the point was that the doctors that were active were doing more and more scripts. So, is that still the case or not?

[Peter Wilensky:]

Yes, I believe the script count went up in Q1. We will get the exact number for you.

[Barry Wilson:]

We had script counts of 2.1 million in script volumes in the second quarter, Jon.

[Jon Hickman:]

Two point one million?

[Richard Spurr:]

When we are doing the first quarter.

[Peter Wilensky:]

Now, you are stamping. Something higher than that, just slightly higher than that.

[Jon Hickman:]

Yes, it was published in your first quarter press release.

[Richard Spurr:]

Yes, that is correct.

[Jon Hickman:]

So, I can go back with that.

[Barry Wilson:]

And around numbers 2.2 in Q1, 2.1 in Q2.

[Jon Hickman:]

So, can you explain to me, you talked about the certification to via electronic subscriber system, whose service base are those and like how long is that going to take you to get that?

[Richard Spurr:]

Well, so the certifications are primarily Rx-Hub and then also SureScripts. To remind everyone, Rx-Hub is the infrastructure partner that provides eligibility so once we have a real patient, we go to them and see if that patient has insurance and if so, with what carrier and specifically what plan type they have. Rx-Hub gives us that capability and the other player is SureScripts which is the channel out to the pharmacies that is the backend of the process where we deliver the electronic script to them and in fact the chosen pharmacy is one that has a connection to SureScripts and those organizations have recently merged and so they are now called SureScripts-RxHub in a creative renaming on their part. We are currently working two separate threads to certification but that overtime, let us say next year, we will start to nail it into one. The two strings of certifications that are underway today have been underway for a number of months. We are expecting to clear our certification this summer or at the latest early fall but I have reason to believe that we are in a marked way ahead of some of our big competitors and you think they are complex and they keep adding more and more complexity to the certification. These entities have to abide by the CMS standards and bear the mechanism by which the rest of all get forced into these standards. Now in our case we have tested those standards years ago so again we are ahead of the curve. But all the new CMS standards, the new formats, the new feature function is all part of the certification.

[Jon Hickman:]

But you have been dealing with these organizations for years, right?

[Richard Spurr:]

Years.

[Jon Hickman:]

I mean you used both those organizations, I mean your system utilizes those.

[Richard Spurr:]

There is absolutely no risk of us…

[Jon Hickman:]

You are operating without certification now, is that what you are telling me?

[Richard Spurr:]

No, the bar moves all the time so we are certified by their current standard but they are working on their next higher standard.

[Jon Hickman:]

They have new standards.

[Richard Spurr:]

Yes, sir. Sorry if I, they are constantly introducing new standards in raising the bar so you got to work within the area all the time, almost clearly, almost constantly in testing out new releases. So, the technological robustness of this infrastructure just continues to grow. Either point here is not a problem for us. The reason I put it in the call is that I think it is, as I mentioned, a barrier to entry and could potentially post some challenges to some of current competitors. When the payer announces the program, this is in every one of them. You got to certify your Rx-Hub and SureScripts and adhere to all the CMS standards. This just goes to say this is not going to be a cottage industry. This time there is going to be a bunch of players. There is going to be a small number of highly sophisticated, well-oiled, technology players that succeed here.

[Jon Hickman:]

I just do not understand why 150 doctors dropout every quarter and why do not they used, I mean, it just seem the better way to do it, can you talk about that for another minute?

[Richard Spurr:]

So, what we have Jon is historical data and we are all hopeful that with these new incentives some of the casual fallout or attrition will be arrested because now…but there is sometimes there are very legitimate reasons. A doctor can join a new practice and that practice may not be wired for e-Prescribing so they leave practice and then go to practice B. That represents attrition for us. Doctors retire, that represents attrition for us. We have statistics and maybe these are dated but we had doctors going to war. We have female physicians that dropout because they get pregnant or quit for a while for maternity leave. So, it is kind of standard stuff and then you do have, I am sure there are some casual attrition which again we think will get largely arrested by the incentives.

[Jon Hickman:]

Then I got to see before but not in a public forum so there is got be several hundred doctors who are trained on the system and who have the device in their drawer who are not using that right now and now, there is an incentive in place to use it. So, is there any chance that some of these guys pick it up and say, "I'll give you a call," and say, "I need to get back into swing of things"…

[Richard Spurr:]

I am sure there is.

[Jon Hickman:]

Have you seen any of that yet or..?

[Richard Spurr:]

I do not have any anecdotal specific information but in some cases, they call us. In other cases, they might just pick it up and start writing again. The tool is not that hard to use. If you got to use it, it will not be that difficult to just pick it up and start using it again and we would only know that in our doctors count overtime.

[Jon Hickman:]

So, do you have any plans to contact these guys?

[Richard Spurr:]

We will be contacting them. Let us remember two on this incentive thing, it is effective January 1. The law went to effect two weeks ago. So, some of this changes in the way people behave are, we believe, going to a curve but it is a little bit too early to actually know that. But, yes, is the answer to your question and the plans will be contacting them.

[Jon Hickman:]

Okay and then, could you tell us the depreciation in the quarter?

[Barry Wilson:]

Yes, depreciation in the quarter was $320,000.

[Jon Hickman:]

And just one last question, do you have any other customers that have a cap on their paying you on the transactions on the prescription side?

[Barry Wilson:]

No.

[Jon Hickman:]

Just one.

[Barry Wilson:]

Yes, just one contract.

[Jon Hickman:]

Is that a quarterly cap or a yearly cap or..?

[Richard Spurr:]

No, that is a lifetime cap.

[Jon Hickman:]

So, that customer is done for you, basically.

[Richard Spurr:]

No, I would not go there. That should not be your conclusion but under the current contract terms, we are collecting renewal fees from that customer but not transaction fees. There is, it gets even more complicated than that. These are the New Jersey docs specifically. We still have not reached anywhere near our cap on the New York, Connecticut docs. So, this is all probably obviously unsettled, so there is a slag in New Jersey and they have been paying us overtime for that, on a shared savings calculation which we have been representing this transaction based fees as they are and those, that subset in the docs are the ones that are capped. And we have similar mechanism for New York and Connecticut docs but those are…, we will not see the caps there for I do not know what, next years to come.

[Operator:]

Your final question comes from the line of Jackson Spears from Capstone Investments. Please proceed.

[Jackson Spears:]

Can you give us some color on your new orders in Email Encryption, the balance between the banks, healthcare, government and the OEMs? You said you have a million for new orders, where do they come from?

[Richard Spurr:]

So, the data regarding industry is roughly 40% healthcare, this is new business, roughly 40% healthcare, 30% financial, 7% government.

[Jackson Spears:]

And the balance is the OEM?

[Richard Spurr:]

Balance is primarily OEMs, yes.

[Jackson Spears:]

And so, is it you who started with Google or Postini at some time earlier this year in February, you announced the Message Labs in May so the wheel traction in the OEM should not come until some time in the fourth quarter where it becomes statistically significant frame?

[Richard Spurr:]

That is fair. What we said was we would not see signals evident till third quarter and what we said today was in fact, we expect a good third quarter so the signals are positive. It is not going to be, it will be a good third quarter. Let me just leave it at that and the fourth quarter still we do not know but we got some very big companies selling their stuff in a lot of places to a lot of people so and it seems to be taking all.

[Jackson Spears:]

So, would the OEM business, be 20% or 25% of your new Email volume in fiscal '09? Do you have any feel for where it could..?

[Richard Spurr:]

There is no way for us to know that. It could be lower or it could be a lot higher, I do not. [Cross talking] if you think about how many people are selling to how many customers in how many places, we do not have an off the historical data to tell us. It could be explosive. I mean it could just be silly, around 25% but it is too early to say that.

[Jackson Spears:]

And your revenue per subscriber in the OEM is like $12 to $15, correct?

[Richard Spurr:]

$10 to $15 so the larger the customer, the lower the price and the smaller the customer, the higher the price.

[Jackson Spears:]

So, if you added 600,000 subscribers in the next 6 months that will be fairly significant at $10.

[Richard Spurr:]

Sure. I think that will be 6 million.

[Jackson Spears:]

And a question in the e-Prescription and the need to ramp up, would not the payers understand that there is limitations as to your ability to meet their requirement so wouldn’t they be working with you now as to those requirements because it does not sound like you are going to have much traction to late this year or at the earliest or possibly not till 2009 if you do not get any order soon. There is a time like in order and actual deployment.

[Richard Spurr:]

Well, yes of course, so is the timeline for recruiting and…

[Jackson Spears:]

And so, what is that, 90 days before you can ramp up?

[Richard Spurr:]

It is not quite that simply. You can start recruiting the next morning assuming you have a physician list. Our current capacity is 500 so you would cop out on…

[Jackson Spears:]

To get up to 4000, it will take you 90 days or slightly long, if you have an order today.

[Richard Spurr:]

What is the reset?

[Jackson Spears:]

Yes, sir.

[Richard Spurr:]

Yes, I think if it should get up to 4000, yes, it will take longer than 90 days. I mean you have to, as I mentioned, if you have to hire 35 people in that case…

[Jackson Spears:]

Would you give any external financing for that? Would you have to come to the market or look for external sources for that if you got a sudden order from the United or you have now whoever?

[Richard Spurr:]

It would depend Jack on the terms and conditions of the contract. So, if the contract will instruct you to pay you sufficient monies upfront that could fund that hiring, you would not need external financing. If the terms of the contract were we underwrite some of that in exchange for higher returns and they are out here to stand, we would require, not necessarily require funding, it would require, it would depend upon how big the check was and what we felt comfortable with in terms of our current balance sheet but it is conceivable, of course, it could.

[Jackson Spears:]

You mentioned Dr. First, what about Prematics, are you seeing them out in any of among the payers which you are bidding on and are they representing a potential threat to you?

[Richard Spurr:]

Not yet. They announced this thing with a billing company called Availity which is a potential threat inside of the HCSC Company that we are contracted with but we have not seen any single launch or doctor or anything yet so it is not really yet.

[Jackson Spears:]

And when do you think you can initiate profitability on a GAAP basis? It does not sound like you get that this year and might not get it until 2009.

[Richard Spurr:]

We have to get there in '08. We have been pretty clear about that. We have not given any guidance on that Jack and it is because of the unpredictability of the e-Prescribing component and so we have not given that out yet.

[Jackson Spears:]

I was surprised at your pessimism on turnover. I should think with the mandate now from the federal government, retention should be higher going forward.

[Richard Spurr:]

I do not recall being pessimistic on turnover. What are you referring to?

[Jackson Spears:]

I am saying, is that you are saying that every quarter you are replacing certain amount of doctors and should not be somewhat…

[Richard Spurr:]

What I said was there are a certain percentage of those that are a natural course of history. They are going to occur because people leave practices and people retire. That is a fact of life. We should see a lot less attrition because whatever attrition we had from casual drop off should be arrested by the incentives so you are not in an agreement, I am just simply saying it is not going to eliminate attrition all together but we do expect it will improve remarkably our retention rates.

[Jackson Spears:]

Are you in discussion with any of the major people like [Medco] or GE as opposed to using them to assist you and the recruitment of doctors like GE has 130,000 doctors to through IDX?

[Richard Spurr:]

We entertain the idea strategically since we have not solidified any yet.

[Operator:]

At this time, there are no further questions on queue.

[Richard Spurr:]

We are excited. We appreciate your continued interest and support. I think our remark speaks for themselves. Thank you everybody. Stay tuned, call up if you need any more.