Zix Corporation Q3 2009 Earnings Call Transcript

Oct.27.09 | About: Zix Corporation (ZIXI)

Zix Corporation (NASDAQ:ZIXI)

Q3 2009 Earnings Call Transcript

October 27, 2009 5:00 pm ET

Executives

Peter Wilensky – VP, Corporate Development & Government Affairs

Rick Spurr – CEO, Chairman & COO

Susan Conner – CFO

Analysts

Jon Hickman – MDB Capital

Fred Ziegel – Blue Water Capital Markets

Jackson Spears – Robins Securities

Jeb Terry – Aberdeen Investment Management

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2009 Zix Corporation earnings conference call. My name is Junaitha [ph] and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator instructions)

As a remainder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Peter Wilensky, Vice President of Corporate Development and Government Affairs. Please proceed.

Peter Wilensky

Thank you, Junaitha [ph]. Good afternoon and thank you for joining Zix Corporation’s third quarter 2009 conference call. 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 38605390. This information can also be found at investor.zixcorp.com, which is the investors' portion of our website.

Zix Corporation's Chief Executive Officer, Rick Spurr, will begin with an overview of the Company and a discussion of our businesses followed by a discussion of the Q3 2009 financial results by our Chief Financial Officer, Susan Conner. 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 via email, which can be sent to our Investor Relations mailbox, invest@zixcorp.com.

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 beliefs of, assumptions made by, or information currently available to ZixCorp's management team.

Forward-looking statements may include words such as anticipate, believe, expect, forecast, intend, will, could, should or other similar expression. ZixCorp's actual results, performance, prospects or opportunities in 2009 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 Regulation, 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.

Rick Spurr

Thank you, Peter. Good afternoon, and thank you for attending today’s discussion of Zix Corporation’s third quarter results. This earnings call is a very special one for ZixCorp. This past quarter we reached profitability on an adjusted basis for the first time ever in the history of our Company. Given where this Company has been, I think this is a remarkable accomplishment.

Since I joined the Company in 2004, we’ve been making steady progress in improving our financial health. In 2004, we were burning $40 million in cash per year with no prospect of getting the Company as then configured turned around. So, in 2005, we decided to divest several non-core assets and streamline the operations. And in 2008, we became cash flow positive for the first time.

Now, in this third quarter of 2009, we’ve just delivered our first positive adjusted net income. To make sure everyone knows exactly the relationship between our adjusted net income and GAAP measures, our CFO, Susan Conner will discuss the specific adjustments to arrive at adjusted net income later in this call.

Not only did we achieve positive adjusted net income last quarter, but as we look forward, we also have reason to be optimistic. With our subscription model and track record of both consistent new orders and high retention rates combined with a largely fixed cost nature of our service, our continued top line growth should translate into growth and profitability.

As those of you who follow ZixCorp know, our Email Encryption business is the financial engine of the Company. The third quarter yielded another strong performance for this business. Record revenue, increasing margins, a solid result for orders in what typically has been a slower quarter for us, and the movement towards our more typical range with the renewal rates at 91%.

Our new first-year orders were $1.3 million, which is up 12% over Q3 of 2008. And total orders, which also include renewals in the out years of new contracts, was $6.5 million, an increase of 25% over last year’s third quarter.

Healthcare remains strong for us with about half of our new orders coming from this sector. And the HITECH Act, the portion of the stimulus package, which contained, among other things, a significant expansion of the HIPAA laws, was specifically cited by a number of customers as a key driver for seeking out Email Encryption capabilities. The emphasis on security and privacy for healthcare, and specifically patient medical information is not likely to wane.

With a key element of the proposed healthcare reform being the increased use of digital medical records to reduce costs and increase efficiency, the political pressure also to ensure privacy of this information will be great. Since private networks and information exchanges currently don’t exist in the marketplace in any meaningful way, email is the only widespread method for sending information electronically. And these emails need to be encrypted in order to send sensitive information according to the law.

Of course, we are well-positioned as the leader in email encryption in healthcare space where we currently serve several leading national insurers, over 30 Blue Cross Blue Shield organizations, and over 1000 hospitals. This healthcare community is a significant part of our network of users, the largest shared network of users in the industry that now numbers over 18 million.

Our unique architecture of shared identities is simply easier to use because so much of the email communications containing sensitive information is automatically encrypted, sent to its destination, decrypted, and put into the recipient’s mail box completely transparently with no effort required by either sender or receiver. Important components of this service are our sophisticated policy filters, which inspect all outgoing email for specified information and automatically encrypt emails that are triggered by predefined policies, thus making the system both easier and more robust by taking the decision-making out of the sender’s hands.

Both customers and partners alike cite the efficiency and effectiveness of these filters, especially our HIPAA filters as improving their confidence in and the usability our technology. As the new HIPAA laws force email encryption more into the mainstream, we believe that our ease-of-use and ability to provide a technology that works automatically behind the scenes will be even more attractive to potential customers.

As proof of this, I believe these qualities were a key driver in several competitive win-backs we secured this past quarter. Also, as we discussed on last quarter’s call, while the HITECH portion of the stimulus package passed earlier this year did significantly expand HIPAA, many of the strengthened provisions don’t even go into effect until February. So, we were optimistic about continued strong demand in healthcare for at least the next several quarters, and confidence in our ability to win many of these deals.

Financial services also remained a strong sector for us, representing about one-third of our new orders. Open any newspaper and you will find a story of a continued or increasing regulatory pressure on the financial services industry. So, in this environment, many financial institutions don’t want to risk incurring the extra scrutiny from regulators that could come from the publicized breach of confidential information. And, in new more stringent laws that several states have already passed or are currently considering, there is even more pressure on many of these customers to find a solution for protecting sensitive information. All of these drivers have led to success in the financial services industry for ZixCorp.

In Q3, we surpassed the 1100 customer mark for financial services companies, primarily banks and credit unions. And having all of the federal banking regulators and 20 state banking regulators as customers using our service also facilitates the secure communication for banks with the regulators.

Although our sales have been reasonably good despite some weakness from our channel partners, everyone is aware that the economic downturn over the last year or so has constrained spending throughout the industry. While spending on IT projects and overall budgets are projected to decline further in 2010, in their survey of 1000 IT professionals released at the end of August, industry research analyst Gartner forecasted budgets for security software projects to increase by 4% next year, the largest increase in the software category.

Additionally, based on input from our sales force and our partners, we expect that within security software projects, Email Encryption will be a growing sub-segment. And we continue to add to our partners for greater coverage, for instance with Dell acting as a referral partner for our service. While this arrangement is not as tightly connected as our OEM partnerships such as with Google and MessageLabs/Symantec, and therefore for us may not be as large, they are obviously significant in the industry.

So, with demand continuing to look strong in our sector of the economy as well as in both of our core verticals, we remain quite optimistic about the future performance of the Email Encryption business and its ability to drive continued strong performance of the overall Company.

This brings me to our e-Prescribing business. As many of you know, we have retained Allen & Company to assist us in evaluating strategic alternatives for this business. We are making good progress on this front and have narrowed the options we are looking at. So, we hope to be able to report the resolution of this process by the end of this year. But until we have a definitive outcome, there is not much more I want to say on the process at this point.

However, it is important to provide an update regarding our cost structure for e-Prescribing. We scrutinized how we’ve been operating and decided the time was right for a switch to a lower-touch, lower cost model in the way we intend to grow our base of users. As part of our transition to this lower touch deployment model, we have reduced the headcount and taken cost-cutting measures, which Susan will detail in a moment.

None of these actions should, however, be seen as impacting our resolve in pursuing our review of strategic alternatives with Allen & Company. But we simply believe they are the right changes for the business at this point regardless of the outcome of this review.

With that, let me turn the call over to Susan for a review of the financial results of the quarter. Susan?

Susan Conner

Thanks, Rick. And good afternoon to everyone. I want to begin my remarks by commenting on how pleased I am with our results for the quarter having just recorded our first quarter of positive adjusted earnings in the Company’s history. Record revenues in conjunction with expense reduction actions have brought us to where we are today.

Let’s move to the details of the third quarter financial results beginning with revenue. We achieved companywide revenues for the third quarter of $7.8 million, which met the top end of our previously provided guidance of $7.5 million to $7.8 million and which compares to $6.7 million for the third quarter of last year. This revenue was comprised of $6.7 million from Email Encryption and $1.2 million from e-Prescribing.

Email Encryption revenue increased $1.1 million, representing a 20% increase over the comparable 2008 figure. The increase consisted of $100,000 from our OEM channels and $1 million from our non-OEM customers. These increases were due to the growth inherent in our successful subscription model with steady additions to the subscriber base.

e-Prescribing revenue for the third quarter was $1.2 million, which compares to $1.1 million for the third quarter last year. The net increase primarily resulted from the following

First, an approximate $57,000 increase from the transaction or usage-based fees, primarily driven by contract extension. And, second, an approximate $25,000 increase in renewal revenue. Both of these increases reflect the increased physician usage we are experiencing.

Partially offsetting these increases was a reduction in deployment and other revenue, which is consistent with our pause as we complete our strategic review of the business. There were approximately 210 new deployments for the third quarter, which met the e-Prescribing deployment guidance of 200 to 250.

Looking ahead for the fourth quarter, we expect our quarterly e-Prescribing revenues to remain relatively consistent with the third quarter.

Turning back now to the results of the business as a whole, we ended the third quarter with a companywide bookings backlog of $41 million, which is a 13% increase over the bookings backlog of $36.2 million for the third quarter of 2008. We anticipate approximately 60% of the total backlog being recognized into revenue within the next 12 months.

In summary, we are very happy to see the continued year-over-year growth in revenues for the Commodity as well as the strong demand we are seeing in our core verticals healthcare and financial services.

I will now discuss our adjusted gross profit results and the details on our expenses. First, let me remind you that my following comments are based upon adjusted numbers. During the third quarter, we had a reduction in force almost solely related to our e-Prescribing business as part of our ongoing strategy to match headcount requirements to current business needs. You will notice the severance cost associated with this reduction is reflected as an adjustment to our adjusted earnings.

I will comment further on the headcount reductions as part of my review of operating expenses. But for additional insight into the severance costs I mentioned and other adjustments, which include non-cash stock based compensation charges related to stock option grant awards accounted for in accordance with FAS 123R and non-recurring expenses related to our strategic review of the e-Prescribing business segment, I refer you to our reconciliation of GAAP to non-GAAP financial measures table, which are reported in both today’s press release and n our Company website.

We achieved a Companywide adjusted gross profit for the third quarter of $5.8 million or 74% of revenues. This compares to $4.4 million or 66% of revenue for the same quarter last year and on a sequential basis it compares to $51 million or 69% of revenues for the second quarter of 2009.

Rick Spurr

$5.1 million.

Susan Conner

I am sorry, $5.1 million, thanks Rick, $5.1 million or a 69% of revenues for the second quarter of 2009. Thanks.

The Email Encryption adjusted gross profit for the third quarter was $5.6 million compared to $4.6 million in the same period last year, which for both quarters represented 83% of our revenue. The improvement was primarily driven by the $1.1 million increase in revenue partially offset by a $200,000 increase in expense.

As we’ve indicated in the past, these email improvements are a natural result of our subscription business model, and relatively fixed cost structure. As we have discussed in detail in previous quarters, our cost structure remains relatively fixed because our scalability, which is driven by our focus on automating certain services, product simplification, remote deployments, and the application of more efficient and lower technologies.

Our e-Prescribing adjusted gross profit was $210,000 or 18% or revenues compared to a negative $210,000 or 18% of revenues for the same quarter last year. This improvement in our adjusted gross profit is due primarily to a $400,000 reduction in our cost of revenues driven from lower cost between periods due to lower deployments and our focused cost reduction efforts.

With regards to operating expenses, adjusted R&D and SG&A expenses totaled $5.1 million in the third quarter of 2009 compared to $5.1 million for the same period last year. The $100,000 decrease consists of a $100,000 increase for R&D expenses and a $200,000 decrease for SG&A expenses. R&D increased first due to our investment in additional resources for the purposes of making design improvements to reduce VPN deployment time and to improve the rate and capacity of deployment for Zix’s services.

Second, due to launching significant efforts to enable multi-language flexibility in a number of systems. And, third, for ongoing workflow improvements and certification requirements for e-Prescribing.

SG&A expenses decreased in 2009 primarily due to lower headcount resulting from actions taken to align expenses with the needs of our businesses. My normal practice has been to discuss adjusted results primarily, but due to one large non-recurring item that caused the GAAP SG&A expense to increase year-over-year, I want to briefly shift focused to look at the increase in the GAAP number.

For the quarter, GAAP SG&A was up $325,000 compared to the prior year. This increase was due to our conversion to a new third-part stock option program provider, which records stock-based compensation expense ratably throughout the vesting life compared to our legacy system that deferred part of the expense until option grants were fully vested. In order to sink the two systems upon conversion we recorded a non-recurring true-up of $482,000 in the third quarter, most of which was recorded in the SG&A line causing this year-over-year increase.

Both systems fully recognize the correct expense over the full vesting life of the options, so it’s just simply a timing difference. You will notice this adjustment in our reconciliation of GAAP to non-GAAP financial measures schedule, which is included with our press release, and is on our website. There will also be a description in our Form 10-Q of this as well.

We continue to manage our headcount to meet the needs of the business. Additionally, as Rick mentioned, we are transitioning our business to a lower touch, lower cost model. By incorporating more remote selling, deploying, and training into our model, we expect to deploy new doctors with fewer resources and improve our margins. Consistent with this approach, we’ve reduced 12 positions in Q3 and another 14 in this month of October, almost solely involving the e-Prescribing line of business and impacting cost of revenue, R&D, and SG&A expenses.

Severance cost of approximately $200,000 in Q3 and $400,000 in Q4 associated with these eliminated positions are or will be in the case of Q4 excluded from the adjusted net income or loss as a result of their non-recurring nature.

Our capital expenditures for the third quarter were $337,000. Depreciation expense for the quarter is approximately $339,000 and was recorded in the various P&L line items with the majority or approximately 70% of it being recorded in cost of revenues.

Turning to cash flow, cash and cash equivalents at September 30, 2009, were $12.4 million compared with $12.5 million for June 30, 2009, and $13.2 million at December 31, 2008. We had anticipated our cash position to improve by $100,000 to $200,000, by the end of the quarter, but our progress was slowed due to two factors. First, although we believe this change will position us for future earnings, it cost us approximately $200,000 in one-time cash payments for severance to realign the e-Prescribing (inaudible).

And second, we have experienced slower collections as we continue to customers holding payments at the end of the quarter and then remitting their payments in the first week of the following quarter. To this point, in the third quarter, we expected additional cash payments of approximately $400,000 that were not received until the first week of October.

Partially offsetting these additional uses of cash were several of our warrants holders who began to exercise warrants that will be expiring on November 2nd of this year. During the third quarter, 208,000 warrants were exercised for $339,000 in cash. We do continue to believe our declining cash as temporary and will be offset with new business as well as the exercise of additional warrants throughout the rest of the year.

Assuming a stock price of at least today’s close, we anticipate approximately 200,000 of additional warrants will be exercised in the fourth quarter for approximately $360,000. I will conclude my comments by saying that we do expect our year-end cash balance to be approximately 413 million.

Our Companywide adjusted net income for the quarter was $797,000, which compares to $819,000 loss for the same period in 2008. Our adjusted net income per share for the quarter was $0.01 per common share versus an adjusted net loss per share of $0.01 for the same period in 2008.

For our financial outlook, we project our adjusted earnings per basis share for the fourth quarter of 2009 to be between $0.01 and $0.02 per share. These results are supported by our revenue guidance ranging from $7.9 million to $8.1 million, again, reflecting continued growth in Email, but flatness in e-Prescribing due to lower deployments as discussed earlier.

This is truly an exciting time for Zix Corporation. We believe our Company is uniquely positioned to take advantage of the several industry changes. To close my comments, I would like to reiterate how pleased we are with the improvements reflected in our Q3 performance. We look forward to continuing our progress into the future.

With that, I will turn it back to Rick. Rick?

Rick Spurr

Thank you, Susan. The third quarter was an extremely important one for ZixCorp in that we achieved positive adjusted earnings for the first time. As you can see from our guidance, we expect that result to continue in the fourth quarter, representing a significant turning point in the Company’s growth and development. Of course, these achievements are primarily driven by the strong performance of our Email Encryption business and the prospects there look good for continued success.

Compliance with new and expand laws at both the federal and state levels, a renewed emphasis on protecting sensitive and private patients information, a superior Software-as-a-Service offering with the largest and only shared directory of users in the industry, a recognized leadership position, a strong reputation in the marketplace, all should continue to drive success for our Email Encryption business. It’s a matter of right time, right place and right offering for ZixCorp, and we intend to continue to strike while the iron is hot.

As always, I would like to thank all of the key constituents for their continued contributions to our success, our employees, of course, for their hard work and dedication, our customers and partners for their continued business, and our shareholder for their support.

And now, let me turn the call over to operator to see if you have any questions. Thank you.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Jon Hickman with MDB Capital. Please proceed.

Jon Hickman – MDB Capital

Hello, can you hear me?

Susan Conner

Yes.

Rick Spurr

Yes.

Jon Hickman – MDB Capital

I was wondering if you could talk about your ability to retain the doctors that you sign up on this e-Prescribing banner.

Rick Spurr

Yes, sure. So we hadn’t seen any change in retention certainly for the negative. If anything, it’s improving and that’s due to we think longevity of usage by the docs, the longer they use it, the more comfortable they are with it of course. And the legislative landscape that’s made it clear to the medical community that you’ve got to move towards electronic digitization of medical exchanges.

Jon Hickman – MDB Capital

So, could you give us how many doctors are you – are actually actively using these days?

Rick Spurr

We are still just north of 3000 and so whatever attrition we have had, we’ve back-filled with new active docs from new deployments.

Susan Conner

And Jon, to be specific, Rick is right. We are, at the end of September, 3075, so just short of 3100. And we have finally started to see what we have told you guys about for – actually I think we’ve been telling you for about 12 months about this shift to one of our doctor groups on to an EMR and we knew that was coming and that has actually occurred and that’s really the biggest drop that you see in these numbers from the last quarter. So, other than that, we haven’t seen any unusual change in the attrition rate.

Jon Hickman – MDB Capital

Okay, thanks.

Susan Conner

Thank you, Jon.

Operator

Your next question comes from the line of Fred Ziegel with Blue Water Capital Markets. Please proceed.

Fred Ziegel – Blue Water Capital Markets

Hi, everybody.

Rick Spurr

Hello, Fred.

Susan Conner

Hi, Fred.

Fred Ziegel – Blue Water Capital Markets

Couple of questions. Rick – I guess one to Rick and one to Susan – I think you commented that your channel partner revenues were on the weak side, so my question on that part of the business outside of what you can’t control, which is the economy, are there any steps you can take or are planning on taking to get the OEM business moving at a brisker pace than it’s been.

Rick Spurr

Yes, actually it’s a good question, Fred. There are actions that we have taken and I’d be happy to detail some of those for you. The slowdown in the channel contribution that we saw over the last six months or so I would attribute primarily to the economy. But, in the case of MessageLabs, it also was a function of their acquisition by Symantec and the normal that typically occurs as a result of that. But both of those major channel partners and frankly all of them across the board just said, hey, you know, times are tough and customers are deferring decisions, so we saw that. We saw a little bit of that in our direct sales, but frankly not quite as much as apparently our channel partners saw.

To the future and what we are doing to energize those even more, we’ve continued to invest people and time and energy sitting side-by-side with our partners in helping them learn more about encryption, actually sort through leads, we’d help them with their webinars and their outreach marketing activities and we’ve made some adjustments to our compensation internally to make sure we eliminate any sort of channel conflict that might arise and we’ve run a couple of contests with the channels to get them even more energized. And although we aren’t reporting numerical quantitative results from those actions, we are happy about the improved relationship and the activity. So—

Fred Ziegel – Blue Water Capital Markets

Is MessageLabs kind of through their distraction with the Symantec merger?

Rick Spurr

Would I elaborate on that was the question?

Fred Ziegel – Blue Water Capital Markets

I said, do you believe MessageLabs is kind of back to business now that the merger is behind them?

Rick Spurr

I met with the Senior Vice President and who reports to the Symantec CEO, who runs the whole Software-as-a-Service business for them the other day and he is very kind – he showed me his thoughts and perspective on their progress. And he is feeling very good. I mean there is always a period first where you are doing the damps [ph] and trying to determine all the adjustment that need to be made and he reported marked progress on those adjustments. So, all in all, it’s a good report and consistent progress.

Fred Ziegel – Blue Water Capital Markets

Are you seeing people who have been using encrypted emails shifting from a non-premise appliance to an in-the-cloud-service or is it mostly new people coming on that go that direction?

Rick Spurr

So, we are seeing some of that shift, but as you point out and what I think is true is that new business is easier. We’d hoped that that shift would accelerate over time. There is a lot of energy and buzz in the industry about Software-as-a-Service and it’s pretty known – well known now that it’s cheaper and easier. So, we are seeing some competitive win-backs that are moving from on-premise solutions sold by our competitors to our Software-as-a-Service offering. We made reference to some of those competitive win-backs. But, I would say that it’s a progress as opposed to a (inaudible).

Fred Ziegel – Blue Water Capital Markets

Have you in the last quarter or so seen any change in length of contracts?

Susan Conner

No.

Rick Spurr

By length of contracts, Fred, do you mean two year versus one year?

Fred Ziegel – Blue Water Capital Markets

Correct.

Rick Spurr

No.

Fred Ziegel – Blue Water Capital Markets

Okay. And then, one last question for Susan. The 14% headcount reduction done this month, what’s the implication of that OpEx in Q4?

Susan Conner

The headcount will save on an annual basis around a million two, so you can do the math on that on an annual basis, so it would be headcount. Then you may want to burden that with a little bit of benefit cost perhaps and 20% to that.

Fred Ziegel – Blue Water Capital Markets

Okay, thanks.

Susan Conner

Yes.

Rick Spurr

Thank you, Fred. It’s good to have you back.

Fred Ziegel – Blue Water Capital Markets

Yes.

Operator

(Operator instructions) Your next question comes from the line of Jackson Spears with Robins Securities. Please proceed.

Jackson Spears – Robins Securities

Hi, Rick, how are you, sir?

Rick Spurr

Good, Jack, how are you, sir?

Jackson Spears – Robins Securities

Could you give us a feel for your employee count at the end of the quarter and how many employees were remaining in e-Prescribing line [ph] like R&D, selling, G&A, et cetera, so what was is at the end of quarter?

Susan Conner

So, at the end of the quarter, Jack, we had 150 employees. After the reductions that we just made here in the fourth quarter, we have roughly 135 employees. Out of that total, 25, roughly, are in the e-Prescribing business and the remaining are in the Email or corporate side.

Jackson Spears – Robins Securities

And your contracts in e-Prescribing are such, how long are they and are doctors concerned whether you are committed to the business?

Susan Conner

The majority of our contracts with the physicians are for one year I’ll let Rick further comment on it, but I haven’t heard any comments that physicians are concerned about our commitment to the business and we’ve certainly haven’t had any increase in trouble with customers or increase in phone calls from them, so I would perceive that as positive.

Rick Spurr

Yes, it’s you know the reality is that when they are using that – they wake up every morning and they walk and they start using it, they don’t start – doctors don’t spend a lot time thinking about oh my God, what am I going to do. It’s just not the reality they are in, so, no, we are not seeing any concerns expressed, which I think is reflected in the renewals rates that we mentioned earlier in response to Jon.

Jackson Spears – Robins Securities

And with your – clearly your commitment to looking for strategy alternatives, when do you think you’ll get that resolve (inaudible) it seems to taking a lot longer than I was expecting?

Rick Spurr

We had said that we hope – we are hopeful we can conclude something by year-end.

Jackson Spears – Robins Securities

And do you remain positive in that? Do you mean to believe that, excuse me, since–

Rick Spurr

We said it in this call that just earlier it’s in the script we said that we hope to be able to conclude by year-end.

Jackson Spears – Robins Securities

And can you take on any new business in e-Prescribing, if you got a 2000 physician group, could you take that on now or are you basically taking a very defensive posture?

Rick Spurr

So, we could take it on, but we are also very open and forthright and honest than anybody that’s ready to make a big commitment like that ones to know that what this picture is going to look like next year and until we are able to tell them exactly what’s that going to look like. You can imagine it’s a real obstacle when you are selling. So, the answer is we are not out taking orders, and we had a couple that we – again, we are honest with people and said hey, look, we got to figure this out first and so they are – as Susan said, things are on pause there.

Jackson Spears – Robins Securities

David Cook has been with you since I think June. What’s he doing and where is his focus?

Rick Spurr

Was it actually June? Anyway–

Susan Conner

August.

Rick Spurr

I think it was August, but–

Jackson Spears – Robins Securities

Sorry.

Rick Spurr

–so we are really just 60 days into that. David is beginning to behave like a very involved and responsible Board member. He is – being on the Board he is not managing or walking the horse – and by his own admission, he wants to spend some more time getting back into the business and understanding the details before he starts recommending or pushing buttons and I think that’s a fair representation of where we with David. But he is going to be a wonderful addition to the sport and I really look forward to continuing to work with him

Jackson Spears – Robins Securities

Your channel partners like Google or Symantec, was it – or Message, whatever, has there been much of a contribution from them in this quarter in terms of new business?

Rick Spurr

They were off in the third quarter as compared with the third quarter of last year, but again, we attribute that, and I think rightly, to the economy and some of the disruption I mentioned earlier. In terms of the everyday working and the pipeline and the activity and the relationship, it’s as good as it’s ever been for those that you mentioned and the other ones that we continue to work with. Webroot is a new one that’s very exciting. So, I am – as I said earlier, very optimistic about the channels going forward. We were able to – with a little bit of weakness they had it wasn’t dramatic. It was just – we like growth and we’d like especially in the channels you’d expect growth. So, when it’s off on a comparable quarter, year to year, you got to (inaudible) understanding, we think it’s the economy.

Jackson Spears – Robins Securities

And the Email Encryption side, is there any change in your pricing or do the competition or the economy or you can pretty much able to hold your prices?

Rick Spurr

Yes, our prices have held – yes, there is no marked impact on pricing is the simple answer.

Jackson Spears – Robins Securities

And so who do you worry about out there as far as competition is concerned?

Rick Spurr

Well, we’ve always said that Cisco is out there with an on-premise solution that we believe is architecturally inferior and over the long term is not the way this industry is moving. But that having been said, it’s part of a bundled appliance that they sell and they can really (inaudible) us on price. So, if somebody is desperate for cost-cutting as I think some segment of the industry was over the preceding six months, sometimes they will take the hit on the long term on customer satisfaction just to save a few pennies. And Cisco, as we’ve said before, does provide that pressure. But the prevalence of them in terms of wins and them winning business away from us is really not that high. I mean they are a competition, but we are still winning the vast majority of what we are in. So–

Jackson Spears – Robins Securities

And with the healthcare reform happening, or appears to be happening, is there a real thrust where – I think you had 1000 hospitals and will that number be a lot higher in the next year or two because there is not many alternatives to you out there?

Rick Spurr

Well, we’d certainly expected to be. The only thing we can say today is that the sales force has never been busier and when we run these marketing programs, we hold these webinar things that we do a reasonably good job of outreach on them and they’ve been specifically healthcare focused recently and the numbers of attendees and the demonstrated interest is just – it’s not up by a little bit like it’s up a bunch. I think we had 500 to 600 people on our last call. And that’s where it all starts, right, awareness, consideration, preference, send an order, win a deal, booking. So, we got our ways to go but the landscape feels very favorable.

Jackson Spears – Robins Securities

How many sales do you for Email Encryption right now or sales people I should say?

Rick Spurr

We’ve got eight people that go call on customers face-to-face and that number has really been flat for a couple of years, but I would predict their productivity is going to go up. And then on the – mostly focused on small and medium business, customers with less than 1500 employees, we have another, I am going to call it, 11 or 12 people, and that group continues to grow and their productivity continues to represent a bigger and bigger part of our overall volume. So, we are very pleased with that segment of the market as well.

Jackson Spears – Robins Securities

Thanks, Rick.

Rick Spurr

You are welcome, Jack. Thank you for your questions.

Operator

Your next question comes from the line of Jeb Terry with Aberdeen Investment Management. Please proceed.

Jeb Terry – Aberdeen Investment Management

Hi Rick, Susan.

Susan Conner

Hey, Jeb.

Jeb Terry – Aberdeen Investment Management

The HITECH bill, it’s captured my imagination and you mentioned, you said the awareness has never been greater and the 500 attendees I haven’t – I am trying to size what this means for you. I see that your – you had sequential growth in the Encryption – in the third quarter and I – as I recall, I think that’s a seasonal slow quarter. How shall we be looking at into 2010 on the potential for that? And then secondarily, what – I am assuming – help me understand if you – if your product development and your infrastructure is capable of meeting whatever specs is coming out of HITECH Act?

Rick Spurr

Yes, that’s a good question, Jeb, of course, none of us really know, but it sure feels good. In terms of R&D, there are no taxes or demands on our technology that we haven’t already met. So there is nothing there. In terms of scalability of the technology, there are no obstacles. I am told that it’s infinitely scalable, which is kind of fun to hear. So, the only thing that we are attentive to – I don’t even want to say worry about is sales coverage and just being in enough places where these decisions are being made. And if we were always sitting here with our direct sales force, we would feel exposed, but with the sort of coverage we get from SecureWorks, Symantec, the largest software security company in the world, Google, Webroot, and a handful of others, we are feeling pretty doggone good about coverage as well.

I will size the impact – you know, I don’t know, I wish I could. But I mean I am very optimistic it’s got to be big – bigger, but I can't quantify that for you.

Jeb Terry – Aberdeen Investment Management

Okay. And what about Windows 7, is there going to be a I mean (inaudible) is there an upgrade cycle lift or is there anything that requires any investment on your part, how is that going to–?

Rick Spurr

We don’t expect that it will be significant to us in any way. I mean we always are – frankly, it’s never come to my level, so it can't be a big deal. But we are always keeping our software current and updating for new releases, not only large ones like 7 as you relate, but version changes and all the rest, but this is not a significant cost item for us in any way.

Jeb Terry – Aberdeen Investment Management

I see. Well, very good. That’s all from me.

Susan Conner

Thanks Jeb.

Rick Spurr

Thanks again for your interest and question. I wish – I sure wish I can answer that question you asked, Jeb, because I would love to know it too. We are going to be aggressive and stretch our channel and our sales force targets and objectives over the next 18 months, but we’ll have to see what – just how big this can become

Operator

We have follow-up question from the line of Jon Hickman with MDB Capital. Please proceed.

Jon Hickman – MDB Capital

With the – your strategy or your review of what to do with the Email – or the e-Prescribing, could you tell us what you are spending on that unit from an R&D point of view right now, if anything at all?

Susan Conner

I will tell you, Jon, I don’t have the R&D right in front of me, but I can tell you from a total spend for the quarter – bear with me a second – I believe that we spent on a net basis, $1 million, so that increased our revenue minus our cost of revenue and our direct expenses in R&D is going to be a part of that. So, R&D for the quarter, as I said, is a sub component of our direct expenses, which is $1.2 million. So I have got SG&A in there as well.

Rick Spurr

Did it help, Jon?

Susan Conner

Yes, I just don’t have the breakout. I think it will be – I think it will bit better in our Q when we file that.

Jon Hickman – MDB Capital

Okay, but just are spending anything there to keep – I mean since you are –

Susan Conner

Oh, yes, oh, good, okay. Yes, we have (inaudible) people. Go ahead.

Rick Spurr

Well, the value of the asset is dependent upon continued certification capability and all that. So—

Jon Hickman – MDB Capital

Okay. So, I got it.

Rick Spurr

We haven’t done anything stupid there.

Susan Conner

Yes, a fair number of our headcount is still in that. I mean they are keeping that technology fresh. That’s extremely important to the value of that business for us.

Jon Hickman – MDB Capital

Okay.

Susan Conner

Yes, a very little of – any of our headcount reduction was on the R&D side of the shop.

Jon Hickman – MDB Capital

Okay.

Rick Spurr

When we talked about cutting back in the call today, we explicitly said a different way to add new physicians. So, it’s the go-to-market new adds that have – we’ve shifted on primarily. The everyday, keep the engine running, keep the technology fresh, take care of the doctors, we’ve – we’ve held that fairly, fairly flat [ph].

Jon Hickman – MDB Capital

Okay. Thank you.

Susan Conner

Yes.

Operator

At this time, there are no further questions. I would now like to turn the call back over to Rick Spurr.

Rick Spurr

All right. Thank you, again, for all your great questions and thanks for your time and energy. And we’ve said it a hundred times here, we are really happy about the Company being profitable on an adjusted income basis and we look forward to continuing to do that on behalf of our shareholders. So, thanks again for your interest.

Operator

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!