e10vq
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2009
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 0-17995
ZIX CORPORATION
(Exact Name of Registrant as Specified in its Charter)
     
Texas
(State of Incorporation)
  75-2216818
(I.R.S. Employer Identification Number)
2711 North Haskell Avenue
Suite 2200, LB 36
Dallas, Texas 75204-2960
(Address of Principal Executive Offices)
(214) 370-2000
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer oAccelerated filer þ 
Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
     
Class   Outstanding at August 3, 2009
Common Stock, par value $0.01 per share   63,319,482
 
 

 


 

INDEX
     
    Page
    Number
PART I — FINANCIAL INFORMATION
   
Item 1. Financial Statements (Unaudited)
   
  3
  4
  5
  6
  7
  11
  19
  19
   
  19
  19
  20
  21
  21
  21
  22
 EX-31.1
 EX-31.2
 EX-32.1

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ZIX CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
                 
    June 30,     December 31,  
    2009     2008  
    (unaudited)          
ASSETS
               
Current assets:
               
Cash and cash equivalents
  $ 12,494,000     $ 13,245,000  
Marketable securities
    25,000        
Receivables, net
    628,000       476,000  
Prepaid and other current assets
    913,000       1,145,000  
 
           
Total current assets
    14,060,000       14,866,000  
Restricted cash
          28,000  
Property and equipment, net
    2,254,000       2,236,000  
Goodwill
    2,161,000       2,161,000  
Other assets
    309,000       66,000  
 
           
Total assets
  $ 18,784,000     $ 19,357,000  
 
           
LIABILITIES AND STOCKHOLDERS’ DEFICIT
               
Current liabilities:
               
Accounts payable
  $ 1,093,000     $ 512,000  
Accrued expenses
    3,029,000       2,404,000  
Deferred revenue
    14,537,000       14,960,000  
License subscription note payable
    121,000        
 
           
Total current liabilities
    18,780,000       17,876,000  
Long-term liabilities:
               
Deferred revenue
    2,888,000       2,484,000  
License subscription note payable
    250,000        
Deferred rent
    267,000       300,000  
 
           
Total long-term liabilities
    3,405,000       2,784,000  
 
           
Total liabilities
    22,185,000       20,660,000  
Commitments and contingencies (see Note 9)
               
Stockholders’ deficit:
               
Preferred stock, $1 par value, 10,000,000 shares authorized; none issued and outstanding
           
Common stock, $0.01 par value, 175,000,000 shares authorized; 65,646,663 issued and 63,319,482 outstanding in 2009 and 2008
    656,000       656,000  
Additional paid-in capital
    334,977,000       333,608,000  
Treasury stock, at cost; 2,327,181 common shares in 2009 and 2008
    (11,507,000 )     (11,507,000 )
Accumulated deficit
    (327,527,000 )     (324,060,000 )
 
           
Total stockholders’ deficit
    (3,401,000 )     (1,303,000 )
 
           
Total liabilities and stockholders’ deficit
  $ 18,784,000     $ 19,357,000  
 
           
See notes to condensed consolidated financial statements.

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ZIX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2009     2008     2009     2008  
Revenues
  $ 7,371,000     $ 6,958,000     $ 14,627,000     $ 14,157,000  
Cost of revenues
    2,368,000       2,542,000       4,839,000       5,122,000  
 
                       
Gross profit
    5,003,000       4,416,000       9,788,000       9,035,000  
 
                               
Operating expenses:
                               
Research and development
    1,747,000       1,381,000       3,478,000       2,926,000  
Selling, general and administrative
    5,228,000       4,607,000       9,872,000       9,424,000  
 
                       
Total operating expenses
    6,975,000       5,988,000       13,350,000       12,350,000  
 
                       
Operating loss
    (1,972,000 )     (1,572,000 )     (3,562,000 )     (3,315,000 )
 
                               
Other income, net
    73,000       222,000       141,000       338,000  
 
                       
 
                               
Loss before income taxes
    (1,899,000 )     (1,350,000 )     (3,421,000 )     (2,977,000 )
Provision for income taxes
    (26,000 )           (46,000 )     (77,000 )
 
                       
Net loss
  $ (1,925,000 )   $ (1,350,000 )   $ (3,467,000 )   $ (3,054,000 )
 
                       
Basic and diluted loss per common share
  $ (0.03 )   $ (0.02 )   $ (0.05 )   $ (0.05 )
 
                       
Basic and diluted weighted average common shares outstanding
    63,319,482       62,903,431       63,319,482       62,803,638  
 
                       
See notes to condensed consolidated financial statements.

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ZIX CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ DEFICIT

(Unaudited)
                                                 
    Stockholders’ Deficit  
                    Additional                     Total  
    Common Stock     Paid-In     Treasury     Accumulated     Stockholders’  
    Shares     Amount     Capital     Stock     Deficit     Deficit  
Balance, December 31, 2008
    65,646,663     $ 656,000     $ 333,608,000     $ (11,507,000 )   $ (324,060,000 )   $ (1,303,000 )
Employee stock-based compensation costs
                1,353,000                   1,353,000  
Non-employee stock-based compensation costs
                16,000                   16,000  
Net loss
                            (3,467,000 )     (3,467,000 )
 
                                   
Balance, June 30, 2009
    65,646,663     $ 656,000     $ 334,977,000     $ (11,507,000 )   $ (327,527,000 )   $ (3,401,000 )
 
                                   
See notes to condensed consolidated financial statements.

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ZIX CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)
                 
    Six Months Ended June 30,  
    2009     2008  
Operating activities:
               
Net loss
  $ (3,467,000 )   $ (3,054,000 )
Non-cash items in net loss:
               
Depreciation and amortization
    648,000       649,000  
Employee stock-based compensation costs
    1,353,000       1,265,000  
Non-employee stock-based compensation costs
    16,000        
Common stock issued to employees as compensation in lieu of cash
          576,000  
Changes in deferred taxes
    7,000       27,000  
Changes in operating assets and liabilities:
               
Receivables
    (152,000 )     422,000  
Prepaid and other current assets
    374,000       220,000  
Accounts payable
    409,000       90,000  
Deferred revenue
    (19,000 )     819,000  
Accrued and other liabilities
    592,000       129,000  
 
           
Net cash (used in) provided by operating activities
    (239,000 )     1,143,000  
Investing activities:
               
Purchases of property and equipment
    (515,000 )     (544,000 )
Restricted cash and marketable securities, net
    3,000       1,734,000  
 
           
Net cash (used in) provided by investing activities
    (512,000 )     1,190,000  
Financing activities:
               
Proceeds from exercise of stock options
          150,000  
 
           
Net cash provided by financing activities
          150,000  
 
           
(Decrease) increase in cash and cash equivalents
    (751,000 )     2,483,000  
Cash and cash equivalents, beginning of period
    13,245,000       10,524,000  
 
           
Cash and cash equivalents, end of period
  $ 12,494,000     $ 13,007,000  
 
           
See notes to condensed consolidated financial statements.

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ZIX CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
1. Basis of Presentation
     The accompanying condensed consolidated financial statements of Zix Corporation (“ZixCorp,” the “Company,” “we,” “our,” “us”) should be read in conjunction with the audited consolidated financial statements included in the Company’s 2008 Annual Report to Shareholders on Form 10-K. These financial statements are unaudited, but have been prepared in the ordinary course of business for the purpose of providing information with respect to the interim periods. Management of the Company believes that all adjustments necessary for a fair presentation for such periods have been included and are of a normal recurring nature. The results of operations for the three and six month periods ended June 30, 2009, are not necessarily indicative of the results to be expected for the full year. We have evaluated subsequent events for recognition or disclosure through August 5, 2009, which was the date we filed this Form 10-Q with the SEC.
2. Recent Accounting Standards and Pronouncements
     In April 2009, the Financial Accounting Standards Board (the “FASB”) issued FASB Staff Position No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS 107-1”). FSP FAS 107-1 requires disclosures about the fair value of financial instruments whenever a public company issues financial information for interim reporting periods. FSP FAS 107-1 is effective for interim reporting periods ending after June 15, 2009. The Company adopted this staff position upon its issuance, and it had no material impact on its consolidated financial statements. See Note 6 — “Fair Value Measurements” for these disclosures.
     In April 2009, FASB issued Statement of Financial Accounting Standards (“SFAS”) 165, "Subsequent Events.” SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. SFAS 165 was adopted for the quarter ending June 30, 2009. The adoption had no material impact on our consolidated financial statements. See Note 1 — “Basis of Presentation”.
     In June 2009, the FASB issued SFAS 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles.” SFAS 168 identifies the FASB Accounting Standards Codification as the authoritative source of generally accepted accounting principles (“GAAP”) in the United States. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under federal securities laws are also sources of authoritative GAAP for SEC registrants. SFAS 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. We do not expect adoption to have a material impact on our consolidated financial statements.
     In February 2008, the FASB issued FASB Staff Position FSP 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”). FSP 157-2 delayed the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except for items recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until the beginning of the first quarter 2009. Application of SFAS 157 did not have a material impact on our results of operations and financial position upon adoption on January 1, 2009.
     In December 2007, the FASB issued SFAS 141 (revised 2007) “Business Combinations” (“SFAS 141R”). SFAS 141R amends the principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. SFAS 141R also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R was effective for the Company on January 1, 2009, and the Company will apply to all business combinations subsequent to the effective date.
     In December 2007, the FASB issued SFAS 160, “Non-controlling Interests in Consolidated Financial Statements — an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 establishes accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. SFAS 160 is effective for fiscal years beginning after December 15, 2008. Adoption did not have a material impact on our consolidated financial statements.
     In April 2008, the FASB issued FASB Staff Position No. FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible

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Asset. More specifically, FSP FAS 142-3 removes the requirement under paragraph 11 of SFAS 142 to consider whether an intangible asset can be renewed without substantial cost or material modifications to the existing terms and conditions and instead, requires an entity to consider its own historical experience in renewing similar arrangements. FSP FAS 142-3 also requires expanded disclosure related to the determination of intangible asset useful lives. SFAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008. The adoption of this statement did not have any impact on the Company’s consolidated financial statements or footnote disclosures.
3. Segment Information
     We have concluded our business has two reportable segments: Email Encryption and e-Prescribing. Our senior management team measures the performance of each segment and determines the related allocation of resources.
     To determine the allocation of resources, the senior management team generally assesses the performance of each segment based on revenue, gross profit, and direct expenses which include research and development expenses and selling and marketing expenses that are directly attributable to the segments. Most assets and most corporate costs are not allocated to the segments and are not used to determine resource allocation. Any transactions that are considered a one-time occurrence or not likely to be repeated in future periods are excluded from these assessments. The accounting policies of the reportable segments are the same as those applied to the consolidated financial statements.
     “Corporate” includes charges such as corporate management, compliance and other non-operational activities that cannot be directly attributed to a reporting segment.
                                                                 
    Three Months Ended June 30, 2009     Three Months Ended June 30, 2008  
    Email                             Email                    
    Encryption     e-Prescribing     Corporate     Total     Encryption     e-Prescribing     Corporate     Total  
Revenues
  $ 6,379,000     $ 992,000     $     $ 7,371,000     $ 5,667,000     $ 1,291,000     $     $ 6,958,000  
Cost of revenues
    1,088,000       1,280,000             2,368,000       1,059,000       1,483,000             2,542,000  
 
                                               
Gross profit
    5,291,000       (288,000 )           5,003,000       4,608,000       (192,000 )           4,416,000  
Direct expenses
    2,979,000       1,749,000             4,728,000       2,756,000       1,717,000             4,473,000  
 
                                               
Segment contribution (loss)
    2,312,000       (2,037,000 )           275,000       1,852,000       (1,909,000 )           (57,000 )
Unallocated (expense) / Income:
                                                               
Selling, general and administrative
                (2,247,000 )     (2,247,000 )                 (1,515,000 )     (1,515,000 )
Investment and other income
                79,000       79,000                   222,000       222,000  
Interest expense
                (6,000 )     (6,000 )                        
 
                                               
Total
                    (2,174,000 )     (2,174,000 )                     (1,293,000 )     (1,293,000 )
 
                                               
Income (loss) before provision for income taxes
  $ 2,312,000     $ (2,037,000 )   $ (2,174,000 )   $ (1,899,000 )   $ 1,852,000     $ (1,909,000 )   $ (1,293,000 )   $ (1,350,000 )
 
                                               
Depreciation expense
  $ 193,000     $ 92,000     $ 44,000     $ 329,000     $ 182,000     $ 96,000     $ 43,000     $ 321,000  
 
                                               
                                                                 
    Six Months Ended June 30, 2009     Six Months Ended June 30, 2008  
    Email                             Email                    
    Encryption     e-Prescribing     Corporate     Total     Encryption     e-Prescribing     Corporate     Total  
Revenues
  $ 12,621,000     $ 2,006,000     $     $ 14,627,000     $ 10,956,000     $ 3,201,000     $     $ 14,157,000  
Cost of revenues
    2,101,000       2,738,000             4,839,000       2,109,000       3,013,000             5,122,000  
 
                                               
Gross profit
    10,520,000       (732,000 )           9,788,000       8,847,000       188,000             9,035,000  
Direct expenses
    5,735,000       3,594,000             9,329,000       5,623,000       3,552,000             9,175,000  
 
                                               
Segment contribution (loss)
    4,785,000       (4,326,000 )           459,000       3,224,000       (3,364,000 )           (140,000 )
Unallocated (expense) / Income:
                                                               
Selling, general and administrative
                (4,021,000 )     (4,021,000 )                 (3,175,000 )     (3,175,000 )
Investment and other income
                147,000       147,000                   338,000       338,000  
Interest expense
                (6,000 )     (6,000 )                        
 
                                               
Total
                    (3,880,000 )     (3,880,000 )                     (2,837,000 )     (2,837,000 )
 
                                               
Income (loss) before provision for income taxes
  $ 4,785,000     $ (4,326,000 )   $ (3,880,000 )   $ (3,421,000 )   $ 3,224,000     $ (3,364,000 )   $ (2,837,000 )   $ (2,977,000 )
 
                                               
Depreciation expense
  $ 385,000     $ 179,000     $ 84,000     $ 648,000     $ 370,000     $ 193,000     $ 86,000     $ 649,000  
 
                                               

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     Revenues from international customers and long lived assets outside of the United States (“U.S.”) are not material to the condensed consolidated financial statements.
     As mentioned above, the Company generally does not allocate resources based on assets; however, for disclosure purposes total assets by segment are shown below. Assets reported under each segment include only those that provide a direct and exclusive benefit to that segment. Assets assigned to each segment include accounts receivable and related allowances, prepaid and other assets, property and equipment and related accumulated depreciation, goodwill, and intangible assets and related accumulated amortization. All other corporate and shared assets are recorded under “Corporate.”
                 
    June 30, 2009     December 31, 2008  
Total assets:
               
Email Encryption
  $ 3,662,000     $ 3,335,000  
e-Prescribing
    563,000       664,000  
Corporate
    14,559,000       15,358,000  
 
           
Total assets
  $ 18,784,000     $ 19,357,000  
 
           
4. Stock Options and Stock-based Employee Compensation
     As of June 30, 2009, there were 9,661,326 options outstanding and 1,516,051 available for grant. Of this amount, 1,125,403 options were available for grant to employees, non-director consultants and advisors, and 390,648 were available for grant to the Company’s directors. For the three-month and six-month periods ended June 30, 2009, the total stock-based employee compensation expense was recorded to the following line items of the Company’s condensed consolidated statements of operations:
                 
    Three Months     Six Months  
    Ended June 30,     Ended June 30,  
    2009     2009  
Cost of revenues
  $ 59,000     $ 185,000  
Research and development
    49,000       150,000  
Selling, general and administrative
    415,000       1,018,000  
 
           
Stock-based compensation expense
  $ 523,000     $ 1,353,000  
 
           
     There were no stock options exercised for the three-month and six-month periods ended June 30, 2009, and 4,975 options exercised in the three-month period ended June 2008. The recorded excess tax benefit related to the comparable periods in 2009 and 2008 was $0 and $7,000, respectively. A deferred tax asset totaling $422,000 and $382,000, resulting from stock-based compensation expense relating to the Company’s U.S. operations, was recorded for the six-month periods ended June 30, 2009 and 2008, respectively. These deferred tax assets were fully reserved because of the Company’s historical net losses for its U.S. operations. As of June 30, 2009, there was $2,779,000 of total unrecognized stock-based compensation related to non-vested stock-based compensation awards granted under the stock option plans. This cost is expected to be recognized over a weighted average period of 0.81 years.
     Stock Option Activity
The following is a summary of all stock option transactions for the three months ended June 30, 2009:
                                 
                    Weighted Average        
            Weighted     Remaining     Aggregate  
            Average     Contractual Term     Intrinsic  
    Shares     Exercise Price     (Yrs)     Value  
Outstanding at March 31, 2009
    9,687,604     $ 4.47                  
Granted at market price
    3,000     $ 1.22                  
Cancelled or expired
    (29,278 )   $ 3.04                  
Exercised
        $                  
 
                           
Outstanding at June 30, 2009
    9,661,326     $ 4.48       6.23     $ 204,000  
 
                       
Options exercisable at June 30, 2009
    7,997,462     $ 4.79       5.74     $ 66,000  
 
                         

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     At June 30, 2009, we had 630,277 stock options outstanding in which the exercise price was lower than the market value of the Company’s common stock.
     For additional information regarding the Company’s Stock Options and Stock-based Employee Compensation, see Note 4 to the audited consolidated financial statements contained in our Form 10-K for the fiscal year ended December 31, 2008.
5. Supplemental Cash Flow Information
     Supplemental cash flow information relating to taxes and non-cash activities:
                 
    Six Months Ended June 30,
    2009   2008
Cash income tax payments
  $ 142,000     $ 84,000  
Non-cash investing and financing activities:
               
Assets sold to customers as part of their subscription service
  $ 2,000     $ 16,000  
Stock issued in lieu of accrued expenses
  $     $ 422,000  
Payables related to purchases of fixed assets
  $ 153,000     $  
Issuance of license subscription note payable
  $ 390,000     $  
Amounts reclassified from Notes payable to Accounts payable
  $ 19,000     $  
6. Fair Value Measurements
     In April 2009, the FASB issued FASB Staff Position No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments.” This staff position requires disclosures about the fair value of financial instruments whenever a public company issues financial information for interim reporting periods. This staff position is effective for interim reporting periods ending after June 15, 2009. We adopted this staff position upon its issuance, and it had no material impact on our consolidated financial statements because we believe the financial assets and liabilities as reported in the Company’s financial statements approximate their respective fair values.
7. Receivables, net
                 
    June 30,     December 31,  
    2009     2008  
Gross accounts receivable
  $ 5,219,000     $ 3,682,000  
Allowance for returns and doubtful accounts
    (43,000 )     (37,000 )
Unpaid portion of deferred revenue
    (4,548,000 )     (3,169,000 )
 
           
Receivables, net
  $ 628,000     $ 476,000  
 
           
     The allowance for doubtful accounts includes all specific accounts receivable which we believe are likely not collectible based on known information and a small general percentage for all accounts receivable greater than 90 days past due, net of those accounts specifically reserved, that could potentially become uncollectible.
     The reduction for deferred revenue represents future customer service or maintenance obligations which have been billed to customers, but remain unpaid as of the respective balance sheet dates. Deferred revenue on our consolidated balance sheets represents future customer service or maintenance obligations which have been billed and collected as of the respective balance sheet dates.
8. Earnings Per Share and Potential Dilution
     The two presentations of earnings per share (basic and diluted) in the condensed consolidated statement of operations are equal in amounts because the assumed exercise of common stock equivalents would be anti-dilutive, as a net loss was reported for each period. Common shares that have been excluded from the computation of diluted loss per common share consist of the following:
                 
    June 30,  
    2009     2008  
Stock options
    9,661,326       9,567,891  
Warrants issued in relation to debt and equity arrangements
    10,260,246       10,434,804  
 
           
Total anti-dilutive securities excluded from EPS calculation
    19,921,572       20,002,695  
 
           
     We do not anticipate issuing stock, unless it is deemed appropriate to invest in significant growth opportunities.

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9. Commitments and contingencies
Leases
     We lease office facilities under non-cancelable operating lease agreements. The following table summarizes our contractual cash obligations as of June 30, 2009:
                                 
    Payments Due by Period  
    Total     1 Year     Years 2 & 3     Beyond 3 Years  
Operating leases
  $ 5,277,000     $ 1,165,000     $ 2,116,000     $ 1,996,000  
Debt (long-term and short-term)
    419,000       148,000       271,000        
 
                       
Total
  $ 5,696,000     $ 1,313,000     $ 2,387,000     $ 1,996,000  
     Contractual lease obligations will be partially offset by the receipt of sublease payments totaling $26,000 for the remainder of 2009.
     In May 2009, we entered into a three year subscription agreement with Microsoft Financing for the right to use Microsoft licenses. This agreement was recorded as, “License subscription note payable” on our June 30, 2009 balance sheet. Over the three year subscription period which commenced in May 2009, we will incur approximately $443,000 of payments for principal and interest spread evenly over each month of the subscription period. We have not entered into any other material, non cancelable purchase commitments at June 30, 2009.
Claims and Proceedings
     We are, from time to time, involved in various legal proceedings that arise in the ordinary course of business. We do not believe the outcome of the legal proceedings in which we are currently a party, either individually or taken as a whole, will have a material adverse effect on our consolidated financial condition, results of operations or cash flows. However, we cannot predict with certainty any eventual loss or range of possible loss related to such matters.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
NOTE ON FORWARD-LOOKING STATEMENTS AND RISK FACTORS
     This document contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements other than statements of historical fact are “forward-looking statements” for purposes of federal and state securities laws, including: any projections of future business, market share, earnings, revenues, cash receipts, or other financial items; any statements of the plans, strategies, and objectives of management for future operations; any statements concerning proposed new products, services, or developments; any statements regarding future economic conditions or performance; any statements of belief; and any statements of assumptions underlying any of the foregoing. Forward-looking statements may include the words “may,” “will,” “predict,” “project,” “forecast,” “plan,” “should,” “could,” “goal,” “estimate,” “intend,” “continue,” “believe,” “expect,” “outlook,” “anticipate,” “hope,” “objective,” and other similar expressions. Such forward-looking statements may be contained in the “Management Discussion and Analysis” section below, among other places.
     Although we believe that the expectations reflected in any of our forward-looking statements are reasonable, actual results could differ materially from those projected or assumed in any of our forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to change and to inherent risks and uncertainties, such as those in this document and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008. We do not intend, and undertake no obligation, to update or revise any forward-looking statement, except as required by federal securities regulations.
Overview
     We are a leader in providing secure, Internet-based applications in a Software as a Service (“SaaS”) model. Our core competency is the ability to deliver these complex service offerings with a high level of availability, reliability, integrity, and — particularly — security. We operate under two reporting segments, Email Encryption Service (“Email” or “Email Encryption”) and e-Prescribing

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Service (“e-Prescribing”) where we offer these services on a subscription basis to our customers who subscribe to use the services for a specified term. Specific to our e-Prescribing business, we announced on June 11, 2009 that we had retained Allen & Company LLC to assist our Board of Directors in investigating strategic alternatives (“Strategic Alternatives Review”) for maximizing value of this business segment. Refer to the section labeled, “Results of Operations” — “Revenue Indicators — Backlog, Orders, and Deployments” below for more information with respect to the Strategic Alternatives Review.
     The business operations and service offerings are supported by the ZixData Center™, a network operations center dedicated to secure electronic transaction processing. The operations of the ZixData Center are independently audited annually to maintain AICPA SysTrust™ certification in the areas of security, confidentiality, integrity and availability. Auditors also produce a SAS70 Type II report on the effectiveness of operational controls used over the audit period. The center is staffed 24 hours a day with a proven 99.99% reliability. Whether it is delivery of email, prescriptions or other sensitive information, we enable communications to be sent in a trusted, safe, and secure manner. This is our core competency and we believe it is a competitive advantage.
Critical Accounting Policies and Estimates
     The preparation of financial statements and related disclosures in accordance with accounting principles generally accepted in the United States requires the Company’s management to make estimates and assumptions that affect the amounts reported in the Company’s condensed consolidated financial statements and accompanying notes. Actual results could differ from these estimates and assumptions. Critical accounting policies and estimates are defined as those that are both most important to the portrayal of the Company’s financial condition and results and require management’s most subjective judgments.
     We describe our significant accounting policies in Note 2, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K, for the year ended December 31, 2009. We discuss our Critical Accounting Policies and Estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2009.
Results of Operations
Second Quarter 2009 Summary of Operations
Financial
    Revenue for the quarter ended June 30, 2009, was $7,371,000 compared with $6,958,000 for the same period in 2008 representing a 6% increase.
 
    Gross profit for the quarter ended June 30, 2009, was $5,003,000 or 68% of revenues compared with $4,416,000 or 63% of revenues for the comparable period in 2008.
Email Encryption — gross profit was $5,291,000 or 83% of revenues compared with $4,608,000 or 81% of revenues for the comparable period in 2008.
e-Prescribing — gross loss was $288,000 or 29% of revenues compared with gross loss of $192,000 or a 15% of revenues for the comparable period in 2008.
    Net loss for the quarter ended June 30, 2009 was $1,925,000 compared with a net loss of $1,350,000 in 2008. Included in the loss for the quarter ended June 30, 2009 was approximately $600,000 of non-recurring severance costs and non-recurring expenses related to the Company’s strategic alternatives review of its e-Prescribing business segment.
 
    Ending cash and cash equivalents were $12,494,000 on June 30, 2009 compared with $13,245,000 on December 31, 2008.
Operations
    For the Email Encryption service, new first year orders (“NFYO” or “NFYOs”) for the quarter ended June 30, 2009, were $1,650,000 and customer contract renewals were 86% on a contract value basis. The renewal rate of 86% was lower than our historical rate of 93% to 95%. The factors driving the non-renewal generally fell into two categories: impact of the economy or competition. The economy has in many cases resulted in reduced IT budgets forcing customers either to cut back on the number of users or services they purchased or, in one instance that we know of, decide to do without an email encryption solution altogether. In other cases, competition was the primary driver which manifested itself either through lower prices or a desire to purchase bundled solutions that included anti-spam and anti-virus services.

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    We deployed approximately 325 new e-Prescribing devices to prescribers and reached approximately 2.5 million electronic prescriptions transacted in the three-month period ended June 30, 2009 (19% higher than the same period in 2008).
Revenues
     Email Encryption and e-Prescribing are primarily subscription-based services. The following table sets forth a period-over-period comparison of the Company’s revenues:
                                                                 
                    3-month Variance                     6-month Variance  
    Three Months Ended, June 30,     2009 vs. 2008     Six Months Ended, June 30,     2009 vs. 2008  
    2009     2008     $     %     2009     2008     $     %  
Email Encryption
  $ 6,379,000     $ 5,667,000     $ 712,000       13 %   $ 12,621,000     $ 10,956,000     $ 1,665,000       15 %
e-Prescribing
    992,000       1,291,000       (299,000 )     (23 %)     2,006,000       3,201,000       (1,195,000 )     (37 %)
 
                                                   
Total revenues
  $ 7,371,000     $ 6,958,000     $ 413,000       6 %   $ 14,627,000     $ 14,157,000     $ 470,000       3 %
 
                                                   
     The increase in Email Encryption revenue was due to the growth inherent in a successful subscription model with steady additions to the subscriber base coupled with a high rate of renewing existing customers. The decline in e-Prescribing revenue was driven primarily by: (i) Fewer new prescriber deployments in 2008 and early 2009 compared with 2007, which led to a decline in deployment fees; (ii) a drop in transaction fee revenue after reaching a contractual cap in one customer program; and (iii) relative to the six-month comparison, a first quarter 2008 one-time revenue catch-up upon reaching certain required deployment-related metrics for a single customer contract.
Revenue Indicators — Backlog, Orders and Deployments
     Company-wide backlog — Our end-user order backlog totals $41,427,000 and is comprised of contractually bound agreements that we expect to fully amortize into revenue. As of June 30, 2009, the backlog was comprised of the following elements: $17,425,000 of deferred revenue that has been billed and paid, $4,548,000 billed but unpaid, and approximately $19,454,000 of unbilled contracts. The total backlog distributed by segment was $39,170,000 for Email Encryption and $2,257,000 for e-Prescribing.
     Our backlog is recognized into revenue as the services are performed. Approximately 60% of the total backlog is expected to be recognized as revenue during the next twelve months. The timing of revenue is affected by both the length of time required to deploy a service and the length of the service contract.
     Email Encryption Orders — Total orders for Email Encryption were $9,966,000 and $8,503,000 for the three-month periods ended June 30, 2009 and 2008, respectively. Total orders include customer orders that management separates into three components for measurement purposes: contract renewals, NFYOs, and in the case of new multi-year contracts, the years beyond the first year of service. NFYOs were $1,650,000 and $1,375,000 for the three months ended June 30, 2009 and 2008, respectively. Regulatory compliance with specific measures including the expansion of HIPAA in the American Recovery and Reinvestment Act and new state laws led to strong demand for our services from new customers. Despite the lower renewal rate, we believe demand will remain strong in the next two quarters.
     e-Prescribing — On June 11, 2009, we announced that we had retained Allen & Company LLC to assist our Board of Directors in investigating strategic alternatives for maximizing the value of the Company’s e-Prescribing business. We continue with business as usual with respect to executing our existing contracts and providing services to our customers. In light of our announcement concerning the assessment of this business, we are no longer in negotiations for the large contract that we discussed previously, which was a contract with a national payor that could have increased our prescriber base significantly.
     With regard to the strategic review of our e-Prescribing business, we are looking at options to maximize the value of this business asset, ranging from ongoing involvement in the industry through a partnership or joint venture where we capitalize on our core competency to host prescription processing to completely exiting this business through a divestiture.
     e-Prescribing revenue has declined, in part, due to the number of deployments falling to approximately 1,000 deployments in the twelve months ended June 30, 2009, from approximately 1,250 in the twelve months ended June 30, 2008. We have approximately 400 sponsored, but not-yet-deployed prescribers in our backlog at June 30, 2009. At our current deployment rates, we cannot achieve our objectives for the e-Prescribing business of becoming cash flow breakeven on a stand-alone basis in the near-term. Absent our signing any additional new contracts, we expect e-Prescribing revenues to remain relatively flat throughout 2009. Even if we do sign new contracts, revenues could remain flat because of the lead times between contract signing, physician recruitment and deployment, which are required for revenue recognition, could be three to six months. There can be no assurance we will be successful in

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expanding our current payor programs or contracting with new payors. If we are not successful in this effort and do not reduce the related operating expenses, then the e-Prescribing line of business will continue to consume cash, and revenues will decline beginning first quarter 2010.
     The level of active users represents the portion of the total deployed base that is using the service on a consistent basis, making it a key indicator for retention and future revenue opportunity. In recent quarters, an average of 75% to 80% of deployed prescribers have become active users. As of June 30, 2009, approximately 3,350 active prescribers were using our service, compared to approximately 3,280 at June 30, 2008. The increase in the number of active prescribers resulted from the addition of newly deployed prescribers partially offset by attrition in the ordinary course of business.
     A large clinic, which accounts for approximately 15% of our total active prescribers, previously notified us that they would discontinue our e-Prescribing Service in 2009 as they completed their migration to a full electronic medical record solution and has begun to do so. Based on the end date of their current service periods and due to the special pricing they receive, the revenue impact in calendar 2009 is expected to be approximately $20,000, while the annualized loss in revenue resulting from this event is estimated at approximately $150,000.
     We recognized $137,000 in total transaction and usage-based fees revenue in the quarter ended June 30, 2009, compared to $308,000 in the same period 2008. This decrease was due to our reaching an upper invoicing limit associated with the usage-based fees included in a single payor contract in the second quarter 2008. The Company currently earns transaction-based fees (or the equivalent) with two health care payors. We continue to pursue revenue opportunities from transaction fees from existing customers. In most cases, there are multiple payors in each market and we believe that those additional non-sponsorship payors may be potential sources for supplemental fees in return for certain services such as formulary display, disease management enrollment, branding, and reporting.
     Other sources for transaction fee revenue include parties who benefit from a real-time, electronic connectivity with PocketScript users. For example, we currently have contracts under which we earn fees for sending prescriptions electronically to pharmacies and for certain transactions involving mail order prescriptions. The number of prescriptions written using the PocketScript Service and transmitted through the ZixData Center™ has continued to grow, with approximately 5 million prescriptions transacted in the first six months of 2009 versus approximately 4.4 million prescriptions in the comparable 2008 period.
     Recently enacted national healthcare legislation indicates interest on the part of the nation’s lawmakers for improving the healthcare system. Beginning with the Medicare Improvements for Patients and Providers Act of 2008 (“MIPPA”) in July 2008 and the more recently enacted American Recovery and Reinvestment Act of 2009, which includes a health IT component labeled the HITECH Act, U.S. lawmakers have indicated that healthcare technology will play a key role in improving the nation’s healthcare system. Electronic prescribing is specifically listed in the 2009 legislation as part of a qualified electronic health record (“EHR”) system. However, the ultimate EHR solution which will be eligible for Federal subsidized incentives is still being defined by the Federal Government which could introduce uncertainty relative to the solution. Accordingly, as healthcare technologies’ role in the improvement of the nation’s healthcare system continues to evolve, we are addressing through our strategic review, the time required and risk associated with the continued investment in this business. As we continue to evaluate all aspects of our e-Prescribing business and the best ways to capitalize on upcoming developments, we are looking at options to maximize the value of this business asset, ranging from ongoing involvement in the industry through partnership or joint venture to completely exiting this business through divestiture.
Cost of Revenues
     The following table sets forth a period-over-period comparison of the cost of revenues by product line.
                                                                 
                    3-month Variance                     6-month Variance  
    Three Months Ended, June 30,     2009 vs. 2008     Six Months Ended, June 30,     2009 vs. 2008  
    2009     2008     $     %     2009     2008     $     %  
Email Encryption
  $ 1,088,000     $ 1,059,000     $ 29,000       3 %   $ 2,101,000     $ 2,109,000     $ (8,000 )     0 %
e-Prescribing
    1,280,000       1,483,000       (203,000 )     (14 %)     2,738,000       3,013,000       (275,000 )     (9 %)
 
                                                   
Total cost of revenues
  $ 2,368,000     $ 2,542,000     $ (174,000 )     (7 %)   $ 4,839,000     $ 5,122,000     $ (283,000 )     (6 %)
 
                                                   
     The cost of revenues improvement for the three-month period ended June 30, 2009 versus the three-month period ended June 30, 2008 resulted primarily from (i) a $139,000 decrease in salary and benefits for individuals performing deployment activities due to a decrease in average headcount, primarily in the e-Prescribing product line, and (ii) a $22,000 decrease in travel expenses, as well as other decreases in various non-people costs primarily associated with decreased deployments and recruitments of our e-Prescribing

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product. The cost of revenues improvement for the six months ended June 30, 2009 compared to the same period in 2008, resulted primarily from (i) a $230,000 decrease in salary and benefits for individuals performing deployment activities due to a decrease in average headcount, primarily in the e-Prescribing product line, (ii) a $53,000 decrease in the cost of performing the annual audit to maintain AICPA SysTrust™ certification in the Company’s data center, and (iii) a $26,000 decrease in travel expenses, partially offset by increased stock based compensation expense.
     Email Encryption — Email Encryption’s cost of revenues is comprised of costs related to operating and maintaining the ZixData Center, a field deployment team, customer service and support and the amortization of Company-owned, customer-based computer appliances. For Email Encryption, a significant portion of the total cost of revenues relates to the ZixData Center, which currently has excess capacity. Accordingly, cost of revenues is relatively fixed in nature and is expected to grow at a much slower pace than revenue.
     e-Prescribing — e-Prescribing’s cost of revenues is comprised of costs related to operating and maintaining the ZixData Center, a field prescriber recruiting team, a field deployment team, customer service and support, training and e-Prescribing device costs. In e-Prescribing, a greater proportion of total cost of revenues relates to prescriber recruiting and field deployment activities and device costs. These are more variable in nature than the ZixData Center and accordingly, e-Prescribing costs are more closely correlated to demand. Thus, an increase in our deployment activities will result in an increase in our year-over-year costs of revenues.
Research and Development Expenses
     The following table sets forth a period-over-period comparison of our research and development expenses:
                                                                 
                    3-month Variance                   6-month Variance
    Three Months Ended, June 30,   2009 vs. 2008   Six Months Ended, June 30,   2009 vs. 2008
    2009   2008   $   %   2009   2008   $   %
Research and development
  $ 1,747,000     $ 1,381,000     $ 366,000       27 %   $ 3,478,000     $ 2,926,000     $ 552,000       19 %
     Research and development expenses consist primarily of salary, benefits, and stock-based compensation for our development staff, and non-people costs associated with enhancing our existing products and services and developing new products and services. The increase in research and development expense for the three-month period ended June 30, 2009 compared to the same period in 2008 was primarily attributable to (i) a $324,000 increase in salary and benefit expense resulting from an increase in average headcount and salary increases involving both product lines, and (ii) a $28,000 increase in IT services, partially offset by decreases in various other non-people expenses associated with research and development activities.
     The increase in research and development expense for the six-month period ended June 30, 2009 compared to the same period in 2008 was primarily attributable to (i) a $450,000 increase in salary and benefit expense resulting from an increase in average headcount and salary increases involving both product lines, (ii) a $20,000 increase in stock-based compensation expense, and (iii) a $28,000 increase in IT services, plus other increases in various other non-people expenses associated with research and development activities primarily related to facility services and support.
     The three and six-month periods ended June 30, 2008, benefited from a one-time cost of revenue deferral of approximately $143,000 specific to an e-Prescribing customer contract.
     New and ongoing development activities in Email Encryption this second quarter included efforts toward further internationalizing our services, enhancing the portfolio feature set, design of new service environments for new partners, and improvement of customer provisioning efficiency. In e-Prescribing, the focus has been on delivery of workflow improvements for the prescription renewal and controlled substance prescribing processes as well as ramping of development activities to enable compliance with emerging CCHIT certification requirements.
Selling, General and Administrative Expenses
     The following table sets forth a period-over-period comparison of our selling, general and administrative expenses:
                                                                 
                    3-month Variance                   6-month Variance
    Three Months Ended, June 30,   2009 vs. 2008   Six Months Ended, June 30,   2009 vs. 2008
    2009   2008   $   %   2009   2008   $   %
Selling, general and administrative
  $ 5,228,000     $ 4,607,000     $ 621,000       13 %   $ 9,872,000     $ 9,424,000     $ 448,000       5 %

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     Selling, general and administrative expenses (“SG&A”) consist primarily of salary, stock-based compensation and benefit costs for marketing, selling, executive and administrative personnel as well as costs associated with, promotions, professional services and general corporate activities. The increase in SG&A expenses in the second quarter of 2009 compared to the same quarter in 2008 reflected (i) a $519,000 increase in salary and benefit expenses due primarily to non-recurring severance costs, (ii) a $75,000 increase resulting from professional services cost related to the Company’s strategic alternatives review of its e-Prescribing business and (iii) increase in legal fees largely offset by decreases across several spending categories including consulting, marketing, and travel expenses. The increase in SG&A expenses for the six month period ending June 30, 2009 compared to the same period in 2008 was due to severance costs and consulting fees associated with the Company’s strategic alternatives review of the e-Prescribing business partially offset by lower spending, primarily in travel and marketing.
Other Income, net
     Other income, net consists primarily of investment income. Investment income was $79,000 and $222,000 for the quarters ended June 30, 2009 and 2008, respectively. The decrease was primarily due to slightly lower cash balances in 2009 and a drop in interest rates between periods. Also included in the second quarter 2009 is interest expense of $6,000 which resulted from a third party note for a 36 month Microsoft license subscription. For the six month period ended June 30, 2009 versus the same period in 2008, Other income, net was $141,000 compared to $338,000. The decrease between periods resulted from a lower cash balance in 2009 plus lower interest rates.
Provision for Income Taxes
     Provision for income taxes was $26,000 and zero for the three-month periods ended June 30, 2009 and 2008, respectively and $46,000 and $77,000 for the six-month periods ended June 30, 2009 and 2008, respectively. The provision relates primarily to the Company’s state income taxes and Canadian Federal and Provincial tax liabilities. The operating losses incurred by the Company’s U.S. operations and the resulting net operating losses for U.S. Federal tax purposes are subject to a $112,734,000 reserve because of the uncertainty of future taxable income. As a result, our 2009 provision for the six-month period ending June 30, 2009 of $46,000 consists of taxes on our Canadian operation totaling $96,000, a small amount of state taxes based on gross revenues and a $56,000 refund for historical U.S. tax credits under certain provisions of the American Recovery and Reinvestment Act of 2009. The 2008 provision consisted of $67,000 for taxes on our Canadian operation and $10,000 for state taxes based on gross revenues.
     We have adopted Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”). Accordingly, there was an insignificant amount of interest expense accrued or recognized related to income taxes for the three-month and six-month periods ended June 30, 2009 and 2008, respectively. There were no penalty-related charges to selling, general and administrative expenses accrued or recognized for the same comparative periods. Additionally, we have not taken a tax position that would have a material effect on the financial statements or the effective tax rate for the three-month and six-month periods ended June 30, 2009. We are currently subject to a three-year statute of limitations by major tax jurisdictions.
     Prior to the adoption of FIN 48, we had recorded a $327,000 tax contingency liability and that amount and the specifics therein have remained unchanged. As of June 30, 2009, the gross amount of our unrecognized tax benefits, inclusive of the $327,000 tax liability was approximately $399,000. Included in this balance are tax positions which, if recognized, would impact our effective tax rate.
     As indicated earlier, the operating losses incurred by our U.S. operations and the resulting net operating losses for U.S. Federal tax purposes are subject to a reserve. Significant judgment is required in determining any reserve recorded against the deferred tax asset. In assessing the need for a reserve, we consider all available evidence, including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies.
     When we begin to generate U.S. taxable income in a future period or if the facts and circumstances on which our estimates and assumptions are based were to change, thereby impacting the likelihood of realizing the deferred tax assets, judgment would have to be applied in determining the amount of reserve no longer required. Reversal of all or a part of this reserve could have a significant positive impact on operating results in the period that it becomes more likely than not that certain of our deferred tax assets will be realized. Additionally, deferred tax assets may be limited in whole or in part by Internal Revenue Code Section 382. As a result, our ability to fully utilize the deferred tax assets, including net operating loss carry forwards, against future taxable income may be limited.
Net Loss
     The Net loss for the second quarter 2009 of $1,925,000 increased $575,000 compared to the loss of $1,350,000 for the same period last year. Gross profit improvement of approximately $600,000 resulting from higher revenue and lower cost of revenue was offset by

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higher expenses in R&D and SG&A as well as a reduction in Other income. As referenced above, R&D expenses increased due primarily to increases in salaries and benefits and the impact of a non-recurring benefit in the prior year. Also, as previously noted, SG&A expense increased primarily due to non-recurring severance costs and professional service fees associated with the Company’s strategic review of its e-Prescribing business segment. Other income in the second quarter of 2009 was down compared to the same period in 2008 due primarily to a lower average cash balance and lower interest rates on invested capital between periods.
Liquidity and Capital Resources
Overview
     Based on our performance over the last four quarters and current expectations, we believe our cash and cash equivalents, and cash generated from operations, will satisfy our working capital needs, capital expenditures, investment requirements, contractual obligations, commitments, future customer financings, and other liquidity requirements associated with our operations through at least the next twelve months. However, we operate only two segments, one of which is still developing and emerging, and is now under review to evaluate future strategic alternatives, which makes predicting future cash flows more difficult. We plan for and measure our liquidity and capital resources through an annual budgeting process. At June 30, 2009, our cash and cash equivalents totaled $12.5 million. Our new debt consisted of a note related to a three-year subscription for Microsoft licenses to be paid on a monthly basis.
     We operate two distinct business segments which are in different stages of their life cycle. Our Email Encryption segment is profitable and its revenue is growing around the 20% mark. Our e-Prescribing segment is generating significant losses and consuming cash while still in an emerging phase. Both are subscription businesses that share a common business model. First, the service is established and maintained, which requires a start-up cost and recurring fixed costs. Subscribers are then acquired and brought onto the service, which requires variable acquisition costs related to recruitment, installation and deployment. Subscribers are recruited with the goal of reaching a level of subscriber payments that exceed the fixed recurring service costs. Therefore, both the rate at which new subscribers are added and the ability to retain subscribers is essential to operational cash flow.
     The recurring nature of the Email Encryption subscription model makes cash receipts naturally rise in a predictable manner assuming adequate subscription renewal and continued new additions to the subscription base. Adding to the predictability is our model of selling primarily three year contracts with the fees paid annually at the inception of each year of service. Although our Email Encryption segment is profitable and easier to predict, we expect our e-Prescribing business to continue to consume cash, although at a somewhat slower pace due to recent cost reductions. As previously announced, this business segment is under review for potential strategic alternatives aimed at maximizing its value.
     Cash and cash equivalents at June 30, 2009 were $12,494,000 down $751,000 from the December 31, 2008 balance, due primarily to lower than anticipated collections for the Email Encryption business. Additionally, we made one-time cash payments totaling approximately $200,000 for severance and outside professional services. Relative to lower than anticipated collections, we have now seen for the past two quarters some impact on cash collections due to the slow economy with customers stretching out their payments to some extent. Nonetheless, we believe this decline in cash to be temporary and will be offset with new business or further costs reductions, or a combination of both later in 2009. We believe we will end 2009 with at least as much cash as we ended 2008 and we continue to manage our overall cash flow in an effort to achieve breakeven or positive cash flow. We believe a significant portion of our spending is discretionary and flexible and that we have the ability to adjust overall cash spending to react, as needed, to any shortfalls in projected cash.
Impact of Current Economic Environment
     Multiple events during 2008 involving the financial sector of the global economy have effectively restricted current liquidity within the capital markets throughout the U.S. and around the world. Despite efforts by U.S. treasury and banking regulators to provide liquidity to the financial sector, capital markets continue to remain constrained and volatile. Although we do not currently expect to seek funding in 2009, we do expect access to the capital markets for all borrowers to be restricted throughout 2009 and possibly longer should capital markets remain dysfunctional.
     Sources and Uses of Cash Summary
                 
    Six Months Ended June 30,
    2009   2008
Net cash (used in) provided by operations
  $ (239,000 )   $ 1,143,000  
Net cash (used in) provided by investing activities
  $ (512,000 )   $ 1,190,000  
Net cash provided by financing activities
  $     $ 150,000  

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     For the first half of 2009, our primary source of liquidity from our operations was the collection of revenue in advance from our customers, accounts receivable from our customers, and the timing of payments to our vendors and service providers. Email Encryption cash collections were impacted by a lower renewal rate, lower up front payments on multi-year contracts, and lower first quarter 2009 NFYOs, as well as the slow down in customer payments possibly caused by economic conditions. Additionally, in the first and second quarters of 2008, we benefited by $576,000 from the issuance of common stock to our employees in lieu of cash compensation. We did not continue this practice in 2009.
     Related to our investing activities in the first six months of 2009, we utilized $515,000 to purchase various computing equipment primarily to satisfy customer contracts. Approximately 60% of these capital purchases were for computer servers for our Email Encryption segment, which are required to deliver our services. In the first six months of 2008, purchases of $544,000 were offset by cash inflow from proceeds for a maturing $1,734,000 certificate of deposit.
     Cash provided from financing activities in the first six months of 2008 resulted from the exercise of warrants and stock options. There was no such activity in the first six months of 2009. Our only debt is from a note for monthly subscription fees for Microsoft user licenses. We have historically used a significant amount of cash to fund debt obligations. We do not expect such funding obligations in the immediate foreseeable future.
Liquidity Summary
     Based on our first six months operating results and current 2009 budget plans, we believe we have adequate resources and liquidity to sustain operations for the next twelve months. As previously announced, we have launched a strategic review of our e-Prescribing business segment, which is a significant user of cash. Consistent with our prior views, we continue to express a lack of willingness, relative to other alternatives, to raise capital by issuing new shares of common stock given the recent low price of the Company’s common stock. Should business results not occur as planned, we would first utilize our existing cash resources and would also consider altering our business plan to augment our cash flow position through cost reduction measures, sales of assets, or other such actions. There can be no assurance, however, that we would be successful in carrying out any of these measures should they become necessary.
Options and Warrants of ZixCorp Common Stock
     We have significant warrants and options outstanding that are currently vested. There is no assurance that any of these options and warrants will be exercised; therefore, the extent of future cash inflow from additional warrant and option activity is not certain. The following table summarizes the warrants and options that were outstanding as of June 30, 2009. The vested shares are a subset of the outstanding shares. The value of the shares is the number of shares multiplied by the exercise price for each share.
                                 
    Summary of Outstanding Options and Warrants
                    Vested        
            Total Value     (included in     Total Value of  
Exercise Price Range   Outstanding     Outstanding     Outstanding)     Vested  
$1.11 - $1.99
    7,519,819     $ 11,487,000       6,685,051     $ 10,322,000  
$2.00 - $3.49
    4,961,352       14,837,000       4,915,911       14,705,000  
$3.50 - $4.99
    4,065,934       18,114,000       3,282,279       14,376,000  
$5.00 - $5.99
    549,260       2,791,000       549,260       2,791,000  
$6.00 - $8.99
    908,483       5,786,000       908,483       5,786,000  
$9.00 - $19.99
    890,381       9,727,000       890,381       9,727,000  
$20.00 - $57.60
    1,026,343       56,222,000       1,026,343       56,222,000  
 
                       
Total
    19,921,572     $ 118,964,000       18,257,708     $ 113,929,000  
Off-Balance Sheet Arrangements
     None.

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Contractual Obligations, Contingent Liabilities and Commitments
     A summary of our fixed contractual obligations and commitments at June 30, 2009 is as follows:
                                 
    Payments Due by Period  
    Total     1 Year     Years 2 & 3     Beyond 3 Years  
Operating leases
  $ 5,277,000     $ 1,165,000     $ 2,116,000     $ 1,996,000  
Debt (long-term and short-term)
    419,000       148,000       271,000        
 
                       
Total
  $ 5,696,000     $ 1,313,000     $ 2,387,000     $ 1,996,000  
     In May 2009, we entered into a three year subscription agreement with Microsoft Financing for the right to use certain Microsoft licenses. This agreement was recorded as, “License subscription note payable” on our June 30, 2009 balance sheet. Over the three year subscription period which commenced in May 2009, we will incur approximately $443,000 of payments for principal and interest with payments spread evenly over each month of the subscription period. We have not entered into any other material, non cancelable purchase commitments at June 30, 2009.
     We have severance agreements with certain employees which would require the Company to pay approximately $1,462,000 if all such employees separated from employment with our Company following a change of control, as defined in the severance agreements. During the second quarter 2009, the Company accrued approximately $338,000 for severance and expects to make the payment in the fourth quarter 2009.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     We have no material changes to the disclosure on this matter made in our Annual Report on Form 10-K for the year ended December 31, 2008.
ITEM 4. CONTROLS AND PROCEDURES
     The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Exchange Act as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2009.
Changes in Internal Controls over Financial Reporting
     During the three months ended June 30, 2009, there have been no changes in our internal control over financial reporting that have materially affected or are reasonably likely to materially affect internal control over financial reporting.
PART II — OTHER INFORMATION
ITEM 1. Legal Proceedings
     See Note 9 to the Condensed Consolidated Financial Statements set forth in this Form 10-Q.
ITEM 1A. Risk Factors
     See Part I, Item 1A, “Risk Factors,” of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008. The risk factors set forth below and in our Form 10-K should be read in conjunction with the considerations set forth above in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008. In addition to the risk factors previously identified in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008, we replace the risk factors entitled “We could be affected by government regulation” with the following:
     We could be affected by government regulation. Exports of software solutions and services using encryption technology, such as our Email Encryption Service, are generally restricted by the U.S. government. Although we have obtained U.S. government approval to export our Email Encryption Service to almost all countries, the list of countries to which our solutions and services cannot be exported could be revised in the future. Furthermore, some countries impose restrictions on the use of encryption solutions and services, such as ours. Failure to obtain the required governmental approvals would preclude the sale or use of our solutions and services in international markets and, therefore, harm our ability to grow sales through expansion into international markets. Our largest OEM partners do sell and distribute our Email Encryption Service in overseas markets.

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     The American Recovery and Reinvestment Act of 2009 contains economic incentives for the adoption of health information technologies, including EHRs that contain an e-prescribing component. The availability of these incentives could negatively impact market acceptance of our stand alone e-Prescribing Service. These economic incentives could favor competitors that offer EHRs that contain an e-prescribing component by fostering the adoption of such EHRs and thus decreasing our market opportunity. Furthermore, the Health Information Technology for Economic and Clinical Health (“HITECH”) provisions of the American Recovery and Reinvestment Act of 2009 amend certain privacy and security provisions of the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”). In furtherance of these HITECH provisions, the Secretary of Health and Human Services has recently published preliminary regulatory guidance applicable to health care providers, health plans, health care clearinghouses and their business associates — all of whom are potential customers for our Email Encryption Service — about the security of personal health information (“PHI”) covered by the privacy and security provisions of HIPAA. Other proposed regulations in furtherance of these HITECH provisions are anticipated in the near-term.
     MIPPA provides for incentive payments to physicians who use e-prescribing and will only be paid to physicians that use an e-prescribing service that complies with certification standards not yet completely defined. The Certification Commission for Healthcare Information Technology (“CCHIT”), a private nonprofit organization that is a federally-recognized certifying body for EHRs, recently announced that it will also promulgate standards for standalone e-prescribing by mid-2009. The Company believes that the Center for Medicare and Medicaid Services (“CMS”) will ultimately adopt CCHIT’s standard for standalone e-prescribing as its official standard for compliance under MIPPA and is preparing to seek certification with CCHIT’s standard. There is no assurance that the Company will be successful in doing so. In 2012, CMS will begin to penalize physicians under MIPPA who are not e-prescribing Medicare prescriptions. While the prospect of this penalty might potentially increase our active user rates and retention rates, there could be adverse effects, such as increased competition or a need for us to change the manner in which we recruit, deploy, and train our physician users. In addition, the incentives and penalties for meaningful use of EHRs under the American Recovery and Reinvestment Act, which contains an e-prescribing component, are much greater than those under MIPPA, so physicians may also opt to adopt EHRs with an e-prescribing component rather than standalone e-prescribing systems such as PocketScript.
     The federal government has also adopted regulations to create an exception to the prohibition on physicians’ referrals to healthcare entities with which they have financial relationships for certain electronic prescribing arrangements, codified at 42 C.F.R. §411.357(v), and an exception to the related federal healthcare anti-kickback rules for certain electronic prescribing arrangements, codified at 42 C.F.R. §1001.952. The purpose of the regulations is to encourage physicians to use electronic prescribing systems to create and deliver prescriptions to the pharmacy. The regulations seek to accomplish this purpose by creating certain safe harbors that are intended to encourage healthcare entities, such as health insurance companies and hospitals, to provide financial incentives to physicians to use electronic prescribing systems. These regulations, as they are interpreted and enforced over time, could provide other participants in the market a competitive advantage or could have currently unforeseen consequences that harm our business.
     Furthermore, boards of pharmacy in the various states in which our e-Prescribing business operates regulate the process by which physicians write prescriptions. While regulations in the states in which our e-Prescribing business currently operates generally permit the electronic writing of prescriptions, such regulations could be revised in the future. Moreover, regulations in states in which our e-Prescribing business does not currently operate may not be as favorable and may impede our ability to support business in these states.
     Also, future state or federal regulation could mandate standards for the electronic writing of prescriptions or for the secure electronic transmittal of personal health information through the Internet that our technology and systems do not comply with, which would require us to modify our technology and systems. Many of these standards are currently being pilot tested in their initial form and may be subject to change, accelerated compliance restrictions or select re-implementations, based on resulting industry recommendations.
     Any or all of the foregoing could require us to incur significant costs, including costs to develop the functionalities and features that may be required as a consequence of the application of new standards, regulations, or certification requirements applicable to one or both of our lines of business. There is no assurance that we will achieve compliance with any new required standards, regulations, or certifications. New standards, regulations, or certification requirements could provide competitive advantage to other participants in our markets. There could be other currently unforeseen consequences of new standards, regulations, or certifications. These consequences could materially harm our business.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
     None.

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ITEM 3. DEFAULTS UPON SENIOR SECURITIES
     None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
     The Company held its Annual Meeting of Shareholders on June 4, 2009. See the Company’s Current Report on Form 8-K, dated June 4, 2009, for a description of the matters considered at the meeting and the voting results with respect to these matters.
ITEM 5. OTHER INFORMATION
     None.

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ITEM 6. EXHIBITS
a. Exhibits
     The following is a list of exhibits filed as part of this Quarterly Report on Form 10-Q:
     
Exhibit No.   Description of Exhibits
3.1
  Restated Articles of Incorporation of Zix Corporation, as filed with the Texas Secretary of State on November 10, 2005. Filed as Exhibit 3.1 to Zix Corporation’s Annual Report on Form 10-K for the year ended December 31, 2005, and incorporated herein by reference.
 
   
3.2
  Amended and Restated Bylaws of Zix Corporation, dated February 4, 2009. Filed as Exhibit 3.1 to Zix Corporation’s Current Report on Form 8-K, dated February 10, 2009, and incorporated herein by reference.
 
   
10.1
  Lease, dated April 9, 2009, between ZixCorp Canada, Inc. and Zix Corporation and Elk Property Management Limited (relating to Zix Corporation’s Ottawa, Canada offices). Filed as Exhibit 10.1 to Zix Corporation’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2009, and incorporated herein by reference.
 
   
31.1*
  Certification of Richard D. Spurr, President and Chief Executive Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
31.2*
  Certification of Susan K. Conner, Chief Financial Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
32.1**
  Certification of Richard D. Spurr, President and Chief Executive Officer of the Company, and Susan K. Conner, Chief Financial Officer of the Company, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
*   Filed herewith.
 
**   Furnished herewith.

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SIGNATURES
     Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
         
  ZIX CORPORATION
 
 
Date: August 5, 2009  By:   /s/ Susan K. Conner    
    Susan K. Conner   
    Chief Financial Officer   
 

23

exv31w1
EXHIBIT 31.1
CERTIFICATION
I, Richard D. Spurr, certify that:
1.   I have reviewed this Quarterly Report on Form 10-Q of Zix Corporation;
 
2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4.   The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
  (a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
  (b)   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
  (c)   Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
  (d)   Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
  (a)   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
  (b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
         
     
Date: August 5, 2009  /s/ RICHARD D. SPURR    
  Richard D. Spurr   
  President and Chief Executive Officer   

 

exv31w2
         
EXHIBIT 31.2
CERTIFICATION
I, Susan K. Conner, certify that:
1.   I have reviewed this Quarterly Report on Form 10-Q of Zix Corporation;
 
2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4.   The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
  (a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
  (b)   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
  (c)   Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
  (d)   Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
  (a)   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
  (b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
         
     
Date: August 5, 2009  /s/ SUSAN K. CONNER    
  Susan K. Conner   
  Chief Financial Officer   

 

exv32w1
         
EXHIBIT 32.1
CERTIFICATION OF CEO AND CFO PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
August 5, 2009
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Ladies and Gentlemen:
     The certifications set forth below are being submitted in connection with the Quarterly Report on Form 10-Q (the “Report”) of Zix Corporation for the purpose of complying with Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Section 1350 of Chapter 63 of Title 18 of the United States Code.
     Richard D. Spurr, the chief executive officer, and Susan K. Conner, the chief financial officer of Zix Corporation, each certifies that to the best of his and her knowledge and in their respective capacities as officers of Zix Corporation:
1.   the Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and
 
2.   the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Zix Corporation.
         
     
  /s/ RICHARD D. SPURR    
  Name:   Richard D. Spurr   
  Title:   President and Chief Executive Officer   
 
     
  /s/ SUSAN K. CONNER    
  Name:   Susan K. Conner   
  Title:   Chief Financial Officer