Zix Corporation Q4 2007 Earnings Call Transcript

| About: Zix Corporation (ZIXI)

Zix Corp (NASDAQ:ZIXI)

Q4 2007 Earnings Call.

February 19, 2008 5:00 pm ET

Executives

Mr. Peter Wilensky - Vice President of Investor Relations.

Mr. Rick Spurr – Chief Executive Officer.

Mr. Barry Wilson – Chief Financial Officer.

Analysts

Nolan Gaudreau - Collins Stewart

Jackson Spears - Capstone Investments

Jeb Terry - Aberdeen Investments

Operator

Good day ladies and gentlemen and welcome to the Zix Corporation fourth quarter fiscal year 2007 earnings conference call. My name is Johida and I will be your coordinator for today. At this time, all participants are in a listen-only mode and we will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions) As a reminder this conference is being recorded for replay purposes. I will now like to turn the presentation over to your host for today’s call Mr. Peter Wilensky, Vice President of Investor Relations. Please proceed.

Peter Wilensky

Thank you Johida. Good afternoon and thank you for joining ZixCorp’s fourth quarter and year-end 2007 conference call. As the operator mentioned, this call is being recorded and a replay will be available after the call’s conclusion from our website or by dialing 1888-286-8010 and entering the access code 12526061. This information can also be found at investor.zixcorp.com which is the investor’s portion of our website.

ZixCorp’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 Q4 and full year 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, 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 belief of assumptions made by or information currently available to Zix Corps management team. Forward-looking statements may include words such as the believe, estimate, expect, may project, will, could, should or other similar expression. Zix Corps 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 Zix Corps filings with the Securities and Exchange Commission. As well as in Zix Corps earnings press release issued earlier today. Except is required by federal securities regulations, Zix Corp 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 everyone. In March I will celebrate my third anniversary as CEO of our Company and while I am proud of how far we’ve come, I’m mostly excited about the tremendous opportunities that still lie before us. We are well positioned for incredible growth and success in our Email Encryption Business and also in the very enviable spot in the e-prescribing market and we can take advantage of these opportunities from a position of strength because of our software as a service model hosted architecture and our stable solidified financial foundation. I will discuss each of our businesses in depth as well as the overall picture of the Company. Before turning the call over to our CFO Barry Wilson for a more detailed discussion of the fourth quarter and year end financial results.

As with any sound structure I will start with the foundation, the Company’s financial condition and then move to discussing our Email Encryption Business followed by e-prescribing. From a corporate perspective we had a very successful year exceeding our goals and revenue growth and cash consumption. Our overall revenue for 2007 of 24.1 million represented more than a 31% growth over 2006 punctuated by a record 7 million fourth quarter that exceeded our guidance. Both businesses provided a healthy contribution to that top line growth which included sequentially increasing revenue for each quarter during the year. We couple that growth and revenue with a substantial bottom line improvement, as measured by the significant decrease in our cash burned in 2007.

Excluding the impact of financing activities for a moment, our cash burn from operation dropped from 18.3 million in 2006 to only 3.1 million in 2007. Over half of this improvement came from growth in cash receipts from each of our business with the reminder resulting from reduced expenses primarily due to the cost cutting activities in 2006. We are proud of these results. We made the difficult decisions and executed in a crisp disciplined way and now we can operate from a position of strength. Given number one, the demonstrated low level of cash burn from operation in 2007 and two the predictable growth in cash receipts that stands from our subscription model, we are confident in our ability to achieve positive cash flow in this current quarter Q1 of 2008 and at least through the first six months of this year and we maintain this confidence in a phase of a potential economic recession again because the recurring nature of our revenue and cash streams in our subscription model where almost 75% of our forecasted cash comes from existing contracts or renewals. Add to all of this the fact that we have now retired all of our debt and it become clear that we built a strong foundation and can focus with confidence on the remarkable opportunities that lie ahead.

Let's drill down now on Email Encryption where we completed another successful year. Our Email Encryption Business continues to be the engine that drives the Company’s financial performance and given our highly differentiated offering, a software is a service hosted architecture. We believe we can establish and maintain a leadership position in this segment well into the future; let me explain. We believe that Email Encryption for secured communications between entities in a community of interest is a new problem requiring a new architecture. The new problem is the sharing of identities securely in a community of interest; that is a community of senders and receivers of secure mail who frequently interact with each other. We have the required architecture and our competitors do not. They are applying an old on premise architecture to this new problem. Our architecture promotes sharing and is interoperable by definition. Their architecture creates silos which prevents sharing and are incompatible by definition. Our architecture benefits from Metcalfe’s law where the value of the network increases exponentially with additional members. Their architecture does not. We believe that the industry is now recognizing these benefits of a hosted software as a service approach to encrypted email putting us in a very strong position.

We have leveraged this superior architecture and leadership to produce strong results. Revenues, orders and cash receipts all grew nicely in 2007 with as predicted, cash from email covering the specific email related costs all of the corporate overheads and a significant portion of the e-Prescribing costs. Total orders for 2007 were 24.2 million, up 38% over 2006. The two metrics we track to measure success in this business, customer renewal rates and that new first year orders scored well in 2007. We renewed 99% of our customer contracts measured on a revenue basis which points to both the customer satisfaction with and the stickiness of our service. New first year orders, that is the portion of our total orders from new business that will amortize to revenue and be collected in cash during the subsequent 12 months with a new record, 5.5 million in 2007, up from 4.7 million in 2006.

Healthcare represented about 50% of these new orders showing resurgence in this sector after slight weakness in 2006. A recent emphasis in HIPAA enforcement as evidenced by CMS’s decision to hire PricewaterhouseCoopers to audit a number of hospitals this year for HIPAA violations and a specific line item in President Bush’s federal budget to hire additional HIPAA enforcement personnel in the Department of Health And Human Services should board well for continued demand in this sector where we are recognized as the clear leader.

Financial services accounted for about one-third of our new first year orders in 2007. Our success, securing regulators continued in 2007 adding the final member of the federal banking regulators, the FTIC early in the year and then the Securities and Exchange Commission, the SEC midway through the year. We have also signed 19 state banking regulators up to this point who together regulate over 50% of the banks in the United States.

We have been informed that a number of these state regulators are sending letters to the banks announcing the deployment of our Email Encryption Service and inviting the banks to consider adopting our technology. That’s a pretty powerful statement. We are also seeing some progress in closing deals with larger financial institutions in the country. Although we’ve yet to issue a press release to this effect. I would like to announce today that we recently signed Comerica Bank as an Email Encryption customer giving us our second bank in the top 25. More importantly we have seen a marked increase in receptivity as the largest financial institutions to a software as a service model for encrypted email, which is being confirmed by industry analysts. So it appears that one of the primary obstacles preventing us from securing deals with the top financial institutions maybe dissipating.

In addition to continued success with our direct sales efforts our growth strategy for Email Encryption includes an increased contribution from our OEM partners, the largest of whole currently are Secure Works and Google. The -- if acquisition of Postini last year. By the way referring back to my earlier remarks about architecture, it’s important to note that these partners Secure Works, Postini and Google are all architected to provide software as a service offering, making our partnerships logical and sound for the future. We are happy with the progress of our channel strategy today, however Google’s acquisition of Postini late last year significantly extends the reach of this channel, so we hope to more than double the new first year orders from our OEM partners in 2008 and going forward.

The initial indications are encouraging. They are certainly much to early to suggest a trend. More specifically when we look at our new first year orders from Postinie for December and January, they were our highest orders ever, but two months is a small sample size, so we can’t draw any conclusions at this point.

Another relevant and a point that has to do with pricing. As many of you know, we had an annual agreement with Postini which as we previously disclosed we renewed with Google in December and we are happy with the improved financial terms solidified in this most recent renewal. Now Zix will collect a new per user, per year price that is between $10 and $20 per year. This speaks well to the value of our service to both our partners and ultimately to the consumers and the end users of our service. At the time of the renewal all that was clear was an intent to continue providing the service along the lines of what we were doing for Postinie pre-acquisition and then earlier this month, specifically on February 5, Google launched its new Email Protection Services. Within these services they are offering called Google Message Encryption, is a service that embeds our Email Encryption Service and is offered not just to Google ex-users, but also to any exchange, lotus notes or group wise users. We are proud if our partnership with them and we are please that they are focusing our message security and offering our service as part of their growing emphasis on serving the enterprise market.

At the same time we continue to peruse OEM partnerships with other large brand name companies and of course if and when there is a material development we will disclose the information as appropriate.

I will now turn to our other core business e-prescribing. Needless the buzz around and excitement free prescribing is incredibly high right now. We see two separate catalysts that could individually or jointly make 2008 a water shed year for this technology with the slide of development and/or private sector expansion. Although I believe that the private sector actually has the greater potential for near term growth in our business. I’ll start with the public sector activity because it’s going through so much attention recently.

Starting back in the middle of 2007 with the release of the Gorman Health Group study, there has been growing support from both inside and outside of the government for mandating, e-prescribing of Medicare prescriptions. Combinating with the introduction of the E-Meds bill in the senate and a corresponding bill in the house, which would have written such a mandate for the prescribing, Medicare prescriptions into law. The bill has bi-partisan and bicameral support as well as the outspoken support of the administration in the person of HHS secretary Michael Levaitt who said in his recent testimony before to senate finance committee in response to a question on mandating e-prescribing “it saves lives, it says money and it’s time.” The E-Meds bill has been rolled into the debate on a more permanent fix for some of Medicare’s bigger issues that need to be revisited in mid-year, which may or may not help its passage.

We have been told by staffers on the hill that any Medicare legislation would include any prescribing mandate, because of our recognized leadership in the industry we have been actively working with the members of congress and their offices to promote the adoption of and mandate for e-prescribing. We believe there is a descent chance that our mandate could be passed into law at some point during 2008 which makes a question; how would a mandate Zix’s Corporation? Its a fair question. I believed any legislation mandating e-prescribing including the proposed bill in its current form would have a phase in period, so it’s unlikely that our mandate would be in effect this year or even next year. Therefore while the existence of our mandate in the future would most likely lower the effort needed to sell Doctors on e-prescribing and would potentially increase our active and retention rates. It’s not clear that there would be an immediate benefit to Zix Corp and it could even possibly be some adverse effects, such as increase competition or a need to change or go to market strategy, depending upon the structure or the reimbursement system. That’s why we believe that while a mandate would most likely benefit the Company in the future, the more immediate catalyst for the acceleration in this business will come from expansion in the private sector.

We have frequently discussed the eight payer sponsors with whom we are contracted including four of the top five health care plans in the country assuming the merger between IBC and Highmark goes through. At least try a few thousands if not 10,000 of doctors in their networks that we can target. Admittedly the addition of new response or docs in 2007 was well below our goals but we did focus on it, continued to work through deploying the doc’s for whom we do have sponsorships and generating quality data on drug stand and medical cost savings for our customers to analyze. In fact we believe that our customers are starting to see this as well that the data on car savings are so compelling that these payers are not going to wait for the government to mandate e-prescribing, but will sponsor the wide spread deployment of the technology themselves to capture these attractive returns.

A few of our customers have published some of this information and we know that other customers are seeing similar if not better results themselves. The ERS collaborative in Massachusetts recently stated in their year end 2007 press release that they are announcing the 5% savings in drug spent by doctors using e-prescribing. First is those that didn’t use the technology. Late last year, EDNA published -- they were seeing a 5% improvement in formulary complaints and a 7% increase engineer prescribing in their pilot with Zix Corp in New Jersey and they have subsequently indicated that more recent results show an even greater impact and our other large national health plan is also seeing positive results from very early experiences and project tracking.

Keep in mind that by our calculation, a 5% shift engineeric usage saves a health plan between $5 and $8 per script. Expansion discussions are taking place, customers are focused and energized around the possibilities and some sculpt and pricing proposals are circulating, but all the essential elements of a deal have not yet been agreed to. For instance all the pricing models have been proposed, they are certainly not finalized and we are uncertain regarding available funding sources. As we look further to the future, we believe we will see the compelling nature of the value proposition increase even more. ROI decisions so far have almost solely been focused on the return on investment and drug savings but we know there are patient safety benefits as well. In the recent eRx collaborative press release, they indicated that 104,000 times in 2007 a prescriber changed the prescription after receiving an alert which works out to be approximately 2.5% of the prescriptions written over the second half of the year.

In previous studies, the Institute of Medicine estimated the cost of an adverse drug event to be up to $2,000. If only half of the $104,000 changed prescriptions would have resulted in an adverse drug event, then this technology could have helped the insurers in Massachusetts save over $100 million in 2007, but so far no one knows for sure. Blue Cross Blue Shield of Massachusetts recently engaged researchers from the Dana-Farber cancer Institute to investigate the safety and economic benefits of these alerts in terms of preventing adverse drug events for patients and for the first time, attempt to estimate the potential cost savings associated with these alerts. The study is expected to be completed early in 2008. Being able to quantify an economic impact from the patient safety benefits would certainly increase the perceived value of this investment for the payers and perhaps more importantly, these payers are starting to see the strategic value beyond just e-prescribing of having a real-time connection to the doctor at the point of care with the ability to deliver patient-specific information to that doctor as he or she is making clinical decisions.

The potential to significantly lower healthcare costs in the United States with such a platform for real-time decision support is enormous. The doctor will be able to get relevant information from a variety of sources not only to assist with the electronic prescribing process but to assist with a variety of decisions having to do with the overall quality of care. For instance, we recently announced a pilot with Blue Cross Blue Shield of Massachusetts for a disease management enrollment alert that would prompt the doctor if a patient might be eligible for a disease management program.

Utilizing our real-time connection at the point of care has several advantages including a timelier enrollment in the program and even more importantly, bringing the patient’s trusted advisor, their doctor, into this decision process. We envision that this would be just one of many additional features and value-added functionality that we would be able to layer onto the real-time connectivity platform that we are deploying into doctors offices across the country. Because our payer sponsors also recognize the strategic value of being able to influence the development of and use of that connectivity, they are willing to concede that influence to one, the government, two; the competition, or three other industry participants and we believe they have every incentive to act sooner rather than later and here again is our architecture that makes the difference. Real-time patient specific decision support at the point of care requires a hosted software as a service architecture not an on-premise silo architecture implemented by most EMR suppliers.

Our solution and ability to deliver is proven. From the prescriber perspective according to the annual eRx collaborative survey, 81% of the survey participants said that they would recommend e-prescribing to a colleague and the payers are happy with their functionality, connectivity, recruiting, deployment, service and reliability and where a sufficient density of membership exists at the doc level, they are happy with the ROI even when their only visibility to proven savings is related to drugs spent. As we have said we are engaged in expansion discussions in several accounts. Two of those all be it smaller ones, are very close to launching. We have recently signed an expansion with the eRx collaborative to deploy another 100 new prescribes sponsored by Tufts Health plan and we are also about to launch the next phase of an existing program that should add several hundred doctors on the West Coast.

We also continue to pursue new payers to add to our customer base even though it’s likely they will want to start off with their own pilots. Beyond these two smaller ones mentioned here as we have alluded to, others some larger are being discussed. However, in the past, these decisions have ended up dragging for an extremely long time. So we are reluctant to comment any further at this time. Nonetheless, we remain excited about the opportunities that lie before us.

With that, let me turn the call over to Barry who will provide financial details on the fourth quarter and full year 2007 and after that, I will conclude by giving guidance and closing remarks. Barry.

Barry Wilson

Thanks Rick and good afternoon to everyone on the call today. During the fourth quarter 2007, we continue to progress towards our goals of one; maintaining a strong revenue performance as well as two; continuing to improve our gross margin performance and three; improving the Company’s current cash flow performance thus remaining on track to attain our goal of achieving positive cash flow in the first quarter 2008 and for at least the first half of 2008.

There are four significant items that I will discuss. One, we achieve revenues of $7 million which was above the guidance range previously provided of 6.3 million to 6.8 million. Number two, our gross margin performance for the fourth quarter of 61% of revenues exceeded the 57% performance level recorded in the previous quarter and three; total cash balance for the fourth quarter was 1.9 million exclusive of certain investing and financing activities. Quarter end total cash, cash equivalents and marketable securities were 12.3 million which was ahead of our revised guidance range of 11.5 million to 11.8 million. Total cash burn rate for total year 2007 was 3.1 million, again exclusive of certain investing and financing activities and finally, number four; financing activities in Q4 included the recede of approximately 4.2 million in cash following the exercise of certain outstanding warrants and stock options in part used in Q4 to fully repay the $1.6 million promissory note payable to Sanofi-Aventis. The restructured note which was the Company’s only debt at the time originally called for ratable quarterly principal payments beginning in April 2008 and concluding in January 2010.

Now let’s take a closer review of the financial details. The total revenue of $7 million for the quarter was up 1.5 million or 26% over the 5.5 million for the same quarter in 2006. The $7 million was comprised of 5.3 million for Email Encryption and 1.7 million for e-Prescribing. The 5.3 million for Email Encryption was 1.5 million greater than or a 39% increase over the comparable figure in the fourth quarter of 2006 whereas the e-Prescribing revenue was down ever since lightly the $53,000. The increase are improvement in Email Encryption revenue as a result of continued auditions to the subscriber base for our service coupled with historically consistent high renewal rates for those customers who’s subscriptions have come up for renewal.

For total year 2007, the renewal rate was 99%. The renewal rate is determined by comparing the 12 months dollar value of bookings versus the most recent 12-month dollar value of historical revenue for the same gateway and portal customers.

The revenue for e-Prescribing was 1.7 million for the fourth quarter of 2007, which as I mentioned was a slight decrease that being 3% compared with the same period in 2006. This essentially flat performance between periods reflect strong revenues from transaction or usage based fees and sustained revenues from renewals both offset by lower billable deployment revenue.

In summary, we are pleased with our quarterly year-on-year growth in revenues for Email Encryption and although revenues for e-Prescribing were flat, we believe the potential exists for near-term, new billable deployments which will provide the foundation for future growth. Order bookings for the Company’s services have grown. The company ends with fourth quarter 2007 with a record backlog of 31.8 million compared with the backlog of 26.5 million at the end of the fourth quarter of 2007.

We achieved an overall gross margin of 4.3 million or 61% of revenues. This performance exceeded the 57% of revenues posted in the previous quarter and was a $1.7 million improvement over the fourth quarter in 2006. The Email Encryption gross margin in the fourth quarter was $4.2 million which was 79% of its revenue that is up from a margin of 2.5 million or 66% in the fourth quarter of 2006. The improvement was due to a $1.5 million in the revenue and a $200,000 increase in cost. These improvements are a natural occurrence within our subscription business model which anticipates gross margin performance improving over time by the ongoing addition of new customer orders to the existing customer order base combining with the retention of the existing customer base via a high level of customer renewals which goes with little associated incremental cost. Complimenting the increase in revenue between the comparable periods was a reduction in non-cash expenses.

The e-Prescribing gross margin in the fourth quarter of 2007 was $86,000 or 5.1% of revenues which is a slight improvement over the $66,000 or 4% of revenues in the same period in 2006. As the Company pursues additional new billable deployments, the resulting e-Prescribing mix is expected to produce a less favorable margin in the short term, however, the gross margins will recover and improve as resulting script fees and/or other pay for performance metrics are achieved.

R&D expense in Q4 of 2007 was 1.3 million or approximately 100,000 higher than in Q4 2006. The Q4 2007 performance level was consistent with the average expense for the first three quarters of 2007. Spending in this area of the business continues to be directed at both of our core products.

SG&A expense was 4.3 million in the quarter compared with 4.8 million for the same period in 2006. This reduction reflects principally the Company’s cost reduction actions executed in 2006 to reduce its overhead and certain sales related cost as well as reduce non-cash stock based compensation between periods. The Q4 2007 performance level is slightly lower than the average expense of 4.5 million for the first three quarters of 2007.

For the quarter, all of these activities netted to a Company-wide net loss of $1.4 million compared to a $3.4 million loss for the same period in 2006. The net loss for total year 2007 was 8.1 million inclusive of certain non-recurring items, including a $2 million gain resulting from a customer deposit forfeiture and $100,000 loss on impairment of an operating lease and $255,000 of losses on the extinguishment of debt items. This year-to-date 2007 loss of 8.1 million compares to 19.5 million loss for the same period in 2006.

Finally, we are very pleased with our year-ending cash position of 12.3 million. The resulting cash burn from operations of 3.1 million for total year 2007 compared with 18.3 million for 2006 and with the Company ending the year with no debt from borrowings. These significant improvements are due in part to; one, the cost reductions we implemented throughout 2006; two, our continued cost control in 2007; three, a significant increase in cash receipts in both business which were 45% up over 2006 receipts. Cash receipts for e-mail encryption and e-prescribing where $23.1 million and $6.8 million respectively for the total year 2007 and number four of the Q4 2007 receipts are $4.2 million in cash following the exercises are certain outstanding warrants and stock options during the quarter in part use to fully repay in December 2007 the $1.6 million promissory note payable to Sanofi-Aventis. The only payment of this promissory note did prompt in recording of a one time non-cash loss on extinguish on a debt of $77000 which was included in the $255,000 man I previously mentioned. Now I would like to turn the call back over to Rick.

Rick Spurr

Thank you Barry. Let me give guidance before providing my closing remarks. We forecast revenue in Q1 2008 to be between $6.7 million and $7 million. We remain on track to achieve positive cash flow this quarter, so we are projecting our cash balance at the end of Q1 including marketable securities to be greater than the year end 2007 cash balance of $2.3 million. Although we just signed deals to provide some additional prescribes into the backlog, at this point it’s too late to significantly impact the deployments this quarter so we expect deployments in the first quarter of 2008 to be between 200 and 250. I believe the Company is well positioned for growth and I am optimistic that significant developments are on the horizon. However although I feel very good about where we all is a Company right now no one can predict the future successful, but are existing or new partners. Well I can’t tell you is that we are in a very enviable position as a reputable supplier of highly differentiated, secure software as a service offerings with a solid financial position and a largely recurring revenue stream and as we focus on significant new opportunities we have shown the ability to execute and deliver results. I would like to thank for your attention today. I appreciate the continued support of our employees, customers of course, partners and share holders. Let’s now turn the call over to the operator for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your question comes from the line of Nolan Gaudreau with Collins Stewart. Please proceed.

Nolan Gaudreau - Collins Stewart

I am filling in for Gibb today. How is it going?

Rick Spurr

Good thank you.

Nolan Gaudreau - Collins Stewart

So as far as e-prescribing, what is the current number of active prescribers?

Rick Spurr

I would say here around 33,115.

Nolan Gaudreau - Collins Stewart

Okay and what do you think the attrition rate remains high?

Rick Spurr

So I think the attrition rate -- there’s two answers, one; there is an attrition rate that I think will be part of the map forever, just because in life doctors move around from practices and there is also however some attrition that we saw in 2007 that we have reasonably won’t be repetitive going forward. Very specifically in Massachusetts as we entered 2007, we increased our prices there to the point where they are not paying us a $11,000 per doctor per year, but coincident with that price increase they decided that they were only going to fund and support positions they were writing at a particular script level specifically five scripts a week. So as we went through the year there was some fleshing out if you will of some of those doctors who were writing in a relatively low level and frankly that’s not all bad because if they aren’t writing a lot of scripts, they are not helping the payer or us or frankly patients, so if we’re just spending a lot of money to support doc’s and not get active that isn’t all bad.

Nolan Gaudreau - Collins Stewart

Okay

Rick Spurr

So we think that it was an anomalous follow up but we won’t know I guess till we finish up the rest of 2008.

Nolan Gaudreau - Collins Stewart

Okay would you say payers are holding up on extending programs more meaningfully because they are waiting see what the legislation holds or are they delaying because maybe of uncertainty in the election here?

Rick Spurr

Everybody asked that question and frankly we asked the question ourselves but we are absolutely not seeing that with our current customers. Frankly the reverse is true, the level of interest in activity is actually accelerating and when you ask this specific question about the government, they say “Ah, if our executives wherever had in the sand before that’s no longer the case” they very much appreciate and understand what’s going on, whether your prescribing -- the Medicare groups are becoming involved now where before they were sort of in the back seats, so it’s actually improving rather than receding.

Nolan Gaudreau - Collins Stewart

How much of a competitive threat or a retail threat prescribing capabilities that are built into a broader practice management software suite than it’s like the prescribers already have or that they already have?

Rick Spurr

Do you mean practice management or do you mean the broader suite of electronic medical record capability?

Nolan Gaudreau - Collins Stewart

I -- the broader suite.

Rick Spurr

Yeah, then typical practice management is not clinically related. The broader suite, the AMR capability when it contains here any prescribing component it is certainly a competitor. Now you think I was a superior, but if a practice is going to EMR for their due proceed value and they are willing to spend that money, we are likely to be displaced however it’s very important to note that typical EMR acquisition costs between $12,000 and $30,000 per doctor and therefore the EMR penetration in the lower set of demographics, we believed that to be 75% of the doctors in the United States don’t have the capital nor the IT expertise nor frankly the proceed return on investment to be investing in EMR, so the top end is problematic for us and we’ve focused in 2007 on the 75% of the doc’s that live in practices of five or less, by the way that’s over a $100,000 primary care doctors in the United States and their EMR threat doesn’t seem to be extent there. By the way you asked me earlier about attrition, I forgot to mention that’s another reason why we think we may see a reduction in attrition and that’s because to the extent that we focus on this lower docs who are not moving to EMR, we are not loosing that portion anymore either as we go into the future.

Nolan Gaudreau - Collins Stewart

Okay. As far as Email Encryption, with Google on bundling of the Postini services, do you see any impact on you guys? Does that impact your pricing for them at all.

Rick Spurr

So I'm not sure I know what you mean by they on bundling. What do you mean by that?

Nolan Gaudreau - Collins Stewart

I mean I read that they unbundled into three segments, the Google Message Filtering, the Google Message Security and the Google Message Discovery. I mean does not that not affect you guys at all, that whole bundling?

Rick Spurr

No. So we only live inside the message encryption component and remember how this all evolved. We had integrated our technology with Postini to begin with. Postini then, now run by Google of course, is doing two things. One is they are continuing to sell those products all be it lower price points to everybody they used to sell to before which is every Microsoft user, lotus notes user and group wise user with the Google marketing machine behind them and also they are integrating that capability with us inside into Google apps, but there is nothing about that that’s viewed by us as negative in any way, in fact it’s all positive.

Nolan Gaudreau - Collins Stewart

I mean with their price effect, that doesn’t hurt you guys?

Rick Spurr

No, it hasn’t affected us at all. In fact, our prices went up as we articulated on the call.

Nolan Gaudreau - Collins Stewart

Okay. Postini recently announced that it’s email content filtering service has been enhanced to detect logical expressions like credit card numbers and social security numbers?

Rick Spurr

Yeah.

Nolan Gaudreau - Collins Stewart

Does that affect you guys in your providing to Postini?

Rick Spurr

No, actually not widely known, but to us, irrelevant. The Postini implementation prior to the acquisition forever and going into the future as we see it so far does not use -- has never used our content filters.

Nolan Gaudreau - Collins Stewart

Okay.

Rick Spurr

So the fact that they are enhancing there is only good for all of us, right?

Nolan Gaudreau - Collins Stewart

Yes. Okay, so right. There is just one more question, sorry to bombard you but –-?

Rick Spurr

No. That’s okay.

Nolan Gaudreau - Collins Stewart

Can you -- you think you can review how and how much you guys get paid by Postini?

Rick Spurr

Actually, I just talked about it on this call.

Nolan Gaudreau - Collins Stewart

Oh, okay. I’ll just…

Rick Spurr

Per user per year, it’s between $10 and $20 a year.

Nolan Gaudreau - Collins Stewart

Oh yeah, I remember that, okay. Thank you, that’s it.

Rick Spurr

Sure. Thanks for your questions.

Operator

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

Jackson Spears - Capstone Investments

Rick, congratulation on the progress you made last and in the fourth quarter. It’s good to hear your voice.

Rick Spurr

Thanks Jack.

Jackson Spears - Capstone Investments

Could you give us a feel for the kind of -– when you go to the Google site, they talk about contact sales the kind of support they are providing, this encryption offering.

Rick Spurr

I don’t really have much visibility to that. Our understanding is that you see now they package their various offerings, they have a low-cost $3 packaging option and then $12 option and such. They are expecting lower cost options can be largely sold over the web with credit cards. None of those options contain us. As we understand it, they have taken their telesales resource specifically the Postini telesales resource and those people now call into those existing customer bases and try to explain and up sell to the message encryption capability and that’s about all we know right now.

Jackson Spears - Capstone Investments

There is a lot of noise out in the marketplace about a new health portal and you guys are a big player in healthcare. Could you give us an idea of how many hospitals you sign up, what percent of the market, uses your services in health care?

Rick Spurr

So yeah, we over a 1,000 hospitals, over 30 Blue Cross Blue Shield companies including WellPoint plus Cigna plus Humana and those are ever growing numbers. That’s about as far as we are willing to quantify it Jack at this point.

Jackson Spears - Capstone Investments

Okay. If you look at Google or Yahoo or anybody with a healthcare portal, wouldn’t you be a logical partner for them because you get in overnight make them a big player in healthcare because of the size of your customer base?

Rick Spurr

I don’t know that I want to speculate on that. That’s for you guys to do.

Jackson Spears - Capstone Investments

Thank you. There has been some noise about the G-Phone. Do you have any thoughts on that, with that affects your marketing push with any prescriber?

Rick Spurr

No Jack we are not -- the device is for E-prescribing. We are constantly evaluating both existing technologies as well as new technologies and well it makes sense we add those to the supported list. But it’s a pretty tight filter. These devices have to be extremely realizable, have to have very long battery life, they have to have great form factory, good color, good resolution and think about a way a doctor uses this; they walk in and they use it as they are serving their patients though the say, they are not at the same time doing an E-mail and answering the cell phone. They are servicing the parents and using the prescribing as a decision support tool. So we focus on a specialized very high quality device that’s not to say we ignore the I-phone or smart phones as they come out but right now we are using what the doctor seem to want to use in their everyday practice and medicine.

Jackson Spears - Capstone Investments

Your deferred on your balance sheet, your differed revenue was up a lot for the year and the long term deferred revenue, how much of that is in encryption, how much of that is in E-prescribing?

Barry Wilson

75%, in rough that was 75% of those in Email Encryption and the remainder is e-prescribing I should say.

Jackson Spears - Capstone Investments

And how much of your deferred revenue will be realized in fiscal ’08?

Barry Wilson

In round numbers of about 50%.

Jackson Spears - Capstone Investments

Okay and so that gives you a certain visibility going forward and you indicate that the rates are very high, so life is good in that business.

Rick Spurr

Yes sir.

Jackson Spears - Capstone Investments

Thank you sir on that and what about CapEx for ’08?

Rick Spurr

So we have been running CapEx Jack forever at quarter of a million a quarter on average and that’s a very conscious method for us to constantly update and refresh the hardware and the data center as well as the VPM appliances that live in our customers networks and we see no reason to change that throughout 2008.

Jackson Spears - Capstone Investments

And the last question you made some real parkers on the SG&A line, what do you think that number will look for this year subject to constant variables? It was like $4.2 million to 4.7 in the fourth quarter. Will that continue with that rate, about 4.2 million for every quarter this year?

Rick Spurr

You’ll see some very slight increases due to slight expansions in sales and marketing, sales specifically whether we choose to be more aggressive about that as we move though the years is still on the table.

Jackson Spears - Capstone Investments

So you would be aggressive on the Encryption side and the prescribing side that’s function of variables unknown to you and I at this point.

Rick Spurr

Yes sure and the degree of aggressive on email is also involves some unknowns.

Jackson Spears - Capstone Investments

Okay that you sir.

Rick Spurr

Thanks Jack.

Operator

(Operator Instructions) and your next question come form the line of Jeb Terry with Aberdeen Investments. Please proceed.

Jeb Terry - Aberdeen Investments

Good Afternoon Rick.

Rick Spurr

Hey Jeb.

Jeb Terry - Aberdeen Investments

Rick in your comments you indicated, I think you got a positive cash flow in this quarter perhaps that through Q2 can you provide any additionally color for the reminder of the year beyond Q2?

Rick Spurr

Yeah that’s a great question Jeb, but it’s a rally logically one. We had as we’ve said and proven great visibility particularly for the first six months and pretty down on good visibility for the year but we didn’t want to put out a projection about cash flow positive for the fill year only because we may find ourselves as we move though the year wanting to make some investments and infrastructure to the extent we see very significant growth opportunities and we didn’t want to put our self in a position of having to choose between of course making the right decision to grow business and then adding to be worried or go back on the statement that we made in this call, so we just didn’t want to pay our self into a quarter regarding the second half of the year but borrowing those discretionary expenditures but we do anticipate that we will also achieve positive cash flow for the entire year.

Jeb Terry - Aberdeen Investments

Great. Can you come in on headcount please?

Rick Spurr

Sure, the headcount has been held throughout 2007, very flat. It’s running hard in 75 in round numbers and you’ll see that creep up a little bit, we’re contemplate already made some investments in sales but they are really small, not big deals, but taken management productivity in momentum we are seeing in e-mail and we are contemplating some other investments but again it disappoint nothing that’s meaningful in terms of percentage.

Jeb Terry - Aberdeen Investments

Thanks very much.

Rick Spurr

Thank you Jeb for your questions.

Operator

At this time we don’t have any more questions in the queue and I would like to turn the call back to Mr. Rick Spurr.

Rick Spurr

So team thank you again, thanks everybody for your continued support and attentiveness and great questions and we got to go out and keep producing results. Hang in there this is getting fun. Talk to you later.

Operator

Thank you for you participation in today’s conference. This concludes the presentation and you may now disconnect. Good day.

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