Zix CEO Discusses Q4 2010 Results - Earnings Transcript

| About: Zix Corporation (ZIXI)

Zix Corporation (NASDAQ:ZIXI)

Q4 2010 Earnings Call

February 22, 2011 5:00 pm ET

Executives

Geoff Bibby – VP, Corporate Marketing

Rick Spurr – Chairman, CEO and COO

Mike English – Chief Accounting Officer and Controller

Analysts

Mike Malouf - Craig-Hallum Capital

Fred Ziegel - Blue Water Capital Markets

Jackson Spears – Gar Wood Securities

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter and year end 2010 Zix Corporation Earnings Conference Call. My name is Crystal, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to host for today, Mr. Geoff Bibby. Please proceed.

Geoff Bibby

Thank you, Crystal. As Crystal just mentioned, my name is Geoff Bibby, I am Vice President of Corporate Marketing for Zix Corporation. Thank you for joining our fourth quarter and full-year 2010 conference call. You can find our earnings press release on our investor website at investor.zixcorp.com. The earnings release contains instructions for accessing a recording of this call.

Our Chairman and Chief Executive Officer, Rick Spurr will provide an overview of the company's performance in the quarter, and then our Controller, Mike English, will give you our details of our financial results. Later in the call they will answer questions from analysts and institutional investors. Listeners can also submit questions during the call to our investor relations' mail box at invest@zixcorp.com.

Rick and Mike will provide forward-looking statements on matters such as forecasts of revenues, earnings, operating margins, and cash flow, projections of our contracts or business, and comments on trend information.

The company undertakes no obligation to publicly update or revise any forward-looking statements. Forward-looking statements are subject to risks that could cause actual results to differ materially from our expectations. The risk factors section of the company's most recent Form 10-K filing with the SEC gives examples of those risks.

Rick and Mike will refer to various non-GAAP financial measures such as adjusted gross profit, adjusted operating expenses, adjusted earnings, and adjusted EBITDA. You can find in our earnings press release and on our website detailed explanations of our non-GAAP financial measures along with reconciliations of our adjusting items to the most directly comparable GAAP financial measure.

Now, I'm very pleased to turn the call over to Rick.

Rick Spurr

Good afternoon everybody, and thank you for joining Zix Corporation's fourth quarter and 2010 full-year conference call. I am very pleased to announce another quarter end here of consistent and strong growth from the company on virtually every level. As we have stated over the past few quarters, we continue to build a solid and predictable business based on our successful subscription business model.

Additionally, our results clearly indicate we are transitioning to mainstream demand for email encryption. As data security and integrity issues continue to make headline news, we're also benefiting from recognition of a powerful cloud-based offering along with the growing need for regulatory compliance.

As we stated in our earnings press release issued earlier today, we successfully wound down the E-Prescribing business on December 31 2010 as planned. And as such, our financials for the fourth quarter and the year have been restated to reflect our continuing email encryption operations while treating E-Prescribing as discontinued operations.

The $33.1 million of email encryption revenue we reported for 2010 represents a 25% increase year over year. Included in that number was $8.8 million in encryption email revenue for Q4, which represents a 25% increase over the year-ago quarter and the strongest email encryption quarter in the company's history.

New first year orders for email encryption during the fourth quarter were $2.1 million, giving us a total of $8.7 million in new first-year orders for the year, which represents a 34% increase over 2009. So, we experienced very solid sales performance for email encryption in 2010. We also were able to continue to build our email encryption bookings backlog to the highest levels in the company's history, now at $50 million, a 16% increase over Q4 of 2009.

As you all know, we have reported a GAAP profit in each of the preceding three quarters of this year, and we are pleased to report another GAAP profit for the fourth quarter and, for the first time in company history, a GAAP profit for the year as a whole.

Our non-GAAP net income for the quarter, which excludes the deferred tax asset valuation discussed in the press release, was $2.5 million, or $0.04 a share, and increase of $0.02 per share year over year. We finished the year with non-GAAP net income of $8.4 million, or $0.13 per share, an increase of $0.12 year over year. We generated $7.2 million in cash flow during the year, an increase of $6.6 million over last year, and giving us a cash balance of $25 million at the end of the year.

Another significant accomplishment is that our shared cloud-based Zix directory has now eclipsed 25 million members, including some of the most respected institutions in the country. Our success was driven by strong performances across our three core verticals:healthcare, finance, and government, and, for the first time every, outside of these core verticals in a category we call other.

In addition, it was clearly visible that the growth came from a wider base of distributors, specifically email encryption new business derived from our VAR, OEM, and third-party distribution channels for 2010 was 53% of the total new business compared to 33% in 2009 and represented over 100% growth in volume over 2009. Google continues to be our largest third-party reseller, representing around 10% of our new first-year orders in 2010, and our relationship with them remains strong. We now have 106 managed security service providers and VARs across the country.

Reaching critical mass is an important goal for us to accelerate growth, and our reputation for leadership and excellence in offering a best-of-breed solution is moving us in that direction. Our reputation is also assisting us in our efforts to build a third-party distribution channel. We've been successful in building these third-party relationships, positioning ourselves for what we are now seeing:a heightened demand in the marketplace for our product offerings.

VARs, OEMS, third-party resellers are now augmenting our direct sales force in fulfilling this increased demand. We've been speaking to this increasing demand since 2010 as an important milestone in the mainstream acceptance of our email encryption services, and we expect those trends to continue going forward.

In one of our core vertical markets, there has been an important development from the federal government as it announced its “cloud-first” policy, which requires federal agencies to adopt a cloud-first mentality when considering new IT purchases going forward. Given our strong customer relationships in one of our key vertical markets, we are uniquely positioned to capitalize from initiatives expected from this new policy as result of our cloud-based marketing and our strong OEM relationships, particularly with Google.

Another important core vertical market, which grew substantially in the quarter, was healthcare. Highmark Blue Cross Blue Shield, the fourth largest Blue Shield company in the country, was an important win for us on multiple fronts. It not only expands our presence among the key players in the healthcare market, but what makes it even more rewarding, was our ability to capture new business by displacing an outdated solution from an old competitor.

This old competitor was our largest competitor in the early 2000s, and we believe is still among the top-three vendors in the install base of encrypted email users; however, they appear to be no longer investing in the product and now offer what we in the market believe is outdated and inferior technology and service. This displacement now brings our total number of Blue Cross and Blue Shield customers to 32, clearly a strong position and a critical component of the healthcare market.

We see displacement of obsolete technology as a significant opportunity to further expand our market share within our core verticals. We currently work with one in every five hospitals in the United States,which shows our successful penetration into this market; however, more importantly, highlights a significant opportunity for expansion we could have before us in this key vertical.

Due to amendments to the federal HIPAA rules contained in the HITECH Act, we see covered entities pressuring their business associates and contractors to adopt email encryption. We believe that there are still a lot of companies out there who are covered by HITECH that haven't adopted a solution for email encryption. So we anticipate continued demand in the healthcare sector.

The financial services sector remains another strong vertical for us. Our relationships and success with financial regulators continue to be a healthy source of demand for us actually in two ways. One, we see add-on opportunities, such as our recent expansion within the FDIC, and two, these relationships create demand among the regulated entities, including the banking industry at large. In addition to our current regulators, we're also pleased to report that our technology has been made available to the newly formed consumer financial protection agency. I'm sure many of you know the catalyst for this highly-visible agency was the Dodd-Frank Act.

In addition to our core vertical markets, we witnessed exceptional growth in many of our non-core markets, which we simply call “other.” This demonstrates to us that demand for our products and services fully transcends the legal and regulatory ramifications that have led to our initial success. As demand in these non-core markets grows, the overall revenue pie grows for Zix. It will play an increasingly important role in growing our Zix directory and allow us additional avenues in growing our business. By way of example, some non-core names won during the quarter include large corporations like US Steel, The University of Minnesota, and The Villages in Florida, one of the largest retirement communities in the United States. Overall, this “other” category made up over 20% of our new first-year orders in Q4.

Let me turn now to our differentiation strategy. We've always emphasized ease of use as critical for adoption and compliance. Our customers want to protect their reputations but without adding complexity to their work flow. Our Zix directory and transparent delivery is a perfect example of our superiority. More recently, last week in fact, we raised the bar again, delivering superior ease of use for mobile devices. We announced what I believe will be one of the more exciting rollouts of 2011: Zix Mobility. I truly believe that Zix Mobility is the class in the industry when it comes to simplicity and ease and use with mobile devices. It is easily the most tangible evidence of superior ease of use that we've ever delivered.

US mobile users spend more time using email on their phones than any other internet-based mobile activity, according to a report published by the Nielsen Company. The problem was that practical use of encrypted email on mobile devices had not matched this trend. Our largest competitor makes users go through more than 12 steps to access a secure email on a mobile device. Users of all competitive solutions have had to overcome inconvenient steps, distorted screen layouts, and inefficient implementations to access secure email on mobile devices.

Zix Corp has addressed these challenges to offer enhanced mobile support for email encryption through Zix Mobility. Our approach tailors the layout of messages to make them easily readable on the user's preferred smartphone device, be it the iPhone, Blackberry, or Android. With Zix Mobility, we enable one-click access, and we do all of this without requiring the download of a mobile app. In addition, we believe the architecture of our solution is not easily replicated by our competitors as their push architecture is their only delivery mechanism and cannot be easily modified for mobile delivery.

Okay, now let me a minute, and it will be just the last minute I spend, talking about the E-Prescribing business. We were able to successfully wind down our E-Prescribing business on target and have started the year with a new clean slate. We are pleased to have met the deadlines we conveyed to you in the past, and I am happy that we were able to wind down this business in a very professional, responsible manner, meeting all of our customers commitments and allowing our health insurers and doctors time to react.

In closing, I am very pleased to report the great accomplishments from everyone in our organization. Zix Corp continues to be the leading provider of email encryption services to influential companies in healthcare, finance, and government with very broad and well-known distribution partners, offering our solutions in a market that shows healthy demand under a subscription model that provides stable and predictable revenues.

In 2010 we invested in R&D to continue delivering superior technology and services and capitalized on continued strong demand across the board. Now I would like to turn the call over to Mike English, our controller, to discuss specific financial results for the quarter and provide our guidance for 2011 and then of course we will be happy to take your questions. Mike?

Mike English

Thanks, Rick. Good afternoon to everyone. Before I review our financial results I wanted to first explain a couple of significant changes to our income statement, resulting from the completion of the E-Prescribing wind-down and reduction of our deferred tax asset valuation allowance.

First, the GAAP income statement is restated to reflect the impact of discontinued operation, E-Prescribing operation. This means the revenue and expense numbers on the GAAP income statement exclude E-Prescribing for all periods presented. There in now only one line item for the discontinued operation called “income, loss from discontinued operations.”

Secondly, as mentioned in our last call, we have historically recorded a full valuation allowance related to the deferred tax assets generated by historical losses. It was considered appropriate under generally accepted account principals. Now, due to our positive earnings for the year ended December 31 2010 and the positive earnings from continuing operations for 2009 and 2008, as well as our expectations of future positive earnings, we recorded a $35.3 million decrease to the deferred tax asset valuation allowance, resulting in a tax benefit of that amount in Q4. This is based on guidance under generally accepted accounting principals and applicable tax law.

Now, let's move on to the fourth quarter and the full-year 2010 results. As Rick mentioned, we are pleased to report strong results for the fourth quarter and the full year in our key financial metrics: revenue, GAAP and adjusted net income, EBITDA, and total bookings backlogged.

We have now achieved GAAP profitability in every quarter in 2010 with GAAP net income of $37.2 million in the quarter and $41.2 million for the year. Excluding the impact of the Q4 reduction to our deferred tax asset valuation allowance of $35.3 million, our net income for Q4 was $1.9 million and for the year $5.9 million. Email encryption achieved new first-year orders during the fourth quarter of $2.1 million and $8.7 million for the year, a 34% increase over 2009.

I'll now move to the details of our fourth quarter and full-year financial results, beginning with revenue. The following revenue and expense discussion is related to our continuing operations. We achieved revenues from continuing operations of $8.8 million for the fourth quarter which compared to $7.1 million for the requested of 2009. For full-year 2010, revenue from continuing operations was $33.1 million which compares to $26.4 million for 2009.

E-Prescribing revenues are now included in discontinued operations. For comparison purposes to our most recent revenue guidance, total 2010 revenues including E-Prescribing, were $35.7 million. Fourth quarter revenue from continuing operations grew $1.7 million, a 25% increase over the comparable 2009 figure and full year grew $6.7 million, also a 25% increase over the full year of 2009.

Our OEM partners drove approximately $370,000 of the revenue increase in Q4, a 78% improvement from the fourth quarter a year ago. They drove approximately $1.3 million of the revenue increase for the year 2010, an 81% improvement over 2009. Our direct sales to enterprise and corporate customers, including through our resellers and managed service providers, drove the remaining growth.

We continue to see cumulative growth in our subscription model, where strong orders combine with a high level of renewals. We ended the fourth quarter and the year with email encryption bookings backlog of $49.9 million, which is a 16% increase over the $42.9 million backlog at the end of 2009.

As a reminder to everyone, our backlog is comprised of contractual commitments that we expect to amortize in the future as the services are performed. The revenue recognition of the backlog is affected by both the length of time required to deploy a service and the length of the service contract. We anticipate approximately 55% of the email encryption backlog being recognized into revenue within the next 12 months.

Let's move on to look at our various margins as well as the details on our expenses. We achieved fourth quarter adjusted gross profit continuing operations of $7.2 million, 81% of revenues. This compares to $5.8 million, 82% of revenues for the same quarter last year. On a sequential basis, it compares to $6.9 million or 81% of revenues for the third quarter of 2010. Adjusted gross profit from continuing operations for the full year was $26.8 million, 81% of revenues, compared to $22 million for 2009, 83% of revenue.

Updating our comment from last quarter, while the email encryption gross percent to now be stabilizing, as most of the costs previously allocated to E-Prescribing have been shifted to email encryption, there will be a final shifting of approximately $400,000 in 2011, $100,000 per quarter now that the wind-down is complete. The amount is lower than we projected last quarter due to the accelerated transfer of resources from E-Prescribing to email encryption. This remaining shift of allocated costs will have a minor impact on the gross margin percent going forward, and we expect the percentage to improve as we grow revenue.

With regard to adjusted operating expenses from continuing operations, adjusted R&D and SG&A expenses totaled $5 million for the fourth quarter of 2010 compared to $4.3 million for the same period last year. Adjusted R&D expenses were $1.2 million in the fourth quarter, an increase of $200,000 versus the fourth quarter of 2009. SG&A expenses for the fourth quarter were $3.8 million, an increase of $500,000 over the same period last year.

For the full year of 2010, adjusted operating expenses from continuing operations was $19.5 million as compared to $16.5 million for 2009. Adjusted R&D expenses were $4.9 million for the year, an increase of $1.5 million while SG&A expenses for the year were $14.6 million, also an increase of $1.5 million.

The fourth quarter and full-year increases for R&D were driven not only by the predicted but also accelerated shift of shared expenses from the E-Prescribing business associated with the wind-down of E-Prescribing. This acceleration allowed us to move resources to email encryption at a faster rate than anticipated. The fourth quarter and full-year increases for SG&A were driven by approximately $800,000 of addition commission in bonus expense related to the improved performance of the business and be predicted in accelerated shift in of shared expenses from the E-Prescribing business.

Adjusted operating margin from continuing operations for the fourth quarter was $2.1 million, 24% of revenues. This compares to a margin of $1.6 million, or 20 (inaudible)% of revenues for the same quarter last year. Adjusted operating margin from continuing operations for the year 2010 was $7.2 million, 22% of revenues versus $5.5 million, 21% of revenues for 2009.

Our adjusted EBITDA for the fourth quarter was $2.8 million compared to $1.7 million in the fourth quarter of 2009. For the full year 2010, adjusted EBITDA was $9.9 million compared to $1.9 million for 2009.

Capital expenditures for the fourth quarter were $350,000 and for the full year $1.5 million. Depreciation expense for the quarter was approximately $350,000 and for the year $1.4 million. Depreciation is recorded in the various P&L line items with approximately 80% recorded in cost of revenues.

Ending cash was $24.6 million. Cash and cash equivalents increased $5 million from Q3. Compared to this time last year, cash and cash equivalents increased $11.3 million. The cash increase in the fourth quarter was driven primarily by cash flow from financing of $4.7 million. This inflow resulted from stock option and warrant exercises.

Adjusted net income for the fourth quarter was $2.5 million, which compares to $1.2 million for the same period in 2009. For the full year 2010, adjusted net income was $8.4 million as compared to $506,000 for 2009. Our adjusted net income for fully diluted share of common stock for the quarter was $0.04 versus $0.02 for the same period in 2009, and $0.13 for the full year 2010 versus $0.1 for 2009. Adjust income for fully diluted share of common stock from continuing operations for the quarter was $0.03 versus $0.02 for the same period in 2009. For the year, adjusted income for fully diluted share from continuing operations was $0.11 compared to $0.09 for 2009.

Let's now move to guidance for 2011. For the first quarter of 2011, we project our fully diluted adjusted earnings per share to be $0.03 per share on projected revenue guidance ranging from $9 million to $9.2 million For full year guidance, we project 2011 revenues to be between $38 and $40 million. Fully diluted adjusted earnings per share are projected to be between $0.14 and $0.16 as compared to $0.11 from continuing operations in 2010. This guidance will yield an adjusted EBITDA margin of approximately 30% and an adjusted operating margin in the high 20s.

In closing, I would like to say again that we are very pleased with the results for 2010 and look forward to continued strong performance in 2011.

Rick Spurr

Thank you, Mike. Let me close by making some observations regarding guidance. To reiterate, our revenue guidance for 2011 is $38 to $40 million and our adjusted EPS guidance ranges from $0.14 to $0.16. Comparing to actuals for 2010, on a continuing operations basis, email to email, this gives a revenue growth range from 15-21% and an adjusted EPS growth range of 27-45%. This demonstrates the attractive leverage in our business model. In addition, visibility is quite high in that using the low end of the revenue range, $38 million, 72% of revenue is already contractually committed in our backlog. Using the high end of the range, $40 million, 69% is already committed in our backlog.

With that summary of the numbers, and before I turn it to the operator, I'd like to acknowledge that David Cook has resigned from the Zix Corp board of directors. I'd like to thank David for his service on the board and his many contributions to the Zix Corporation. I'd also like to thank our shareholders for their continued support, our partners and customers for their business, and of course our employees for their dedication and hard work. With that, let me turn it back to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Today's first question come from the line of Mike Malouf with Craig-Hallum Capital. Please proceed.

Mike Malouf – Craig-Hallum Capital

Hey guys, thank for taking my question.

Rick Spurr

Sure.

Mike Malouf – Craig-Hallum Capital

My question is on new first-year orders. I know that you had been bouncing around for about 2.4 which you did last year, down to about 2.1, which you did this quarter. And you also talked a little bit about acceleration coming, and with five quarters in a row sort of in that range, I'm wondering if you could just comment a little bit about acceleration ability or your ability to accelerate out from that $2.1-2.4 million range?

Rick Spurr

Sure. Just to reiterate for everyone, we were running at 1.4 for a very long time, two or three years per quarter on average. Then in the fourth quarter of 2009, it jumped from that average of 1.4 up to, as you said Mike, 2.4. Then we were 2.2 in the first quarter, 2.1 in the second quarter, 2.2 in the third quarter, and 2.1 in the fourth quarter. So it clearly ramped up very quickly, as we've said, because of just increased demand across the board and our ability to satisfy that demand and has been consistent in that 2.1 to 2.2 range as you say.

The question of course is our ability to grow that even more, to accelerate that, and as you know, we don't give guidance on new first-year orders specifically because it's very difficult to predict. We've got lots of reason for optimism given that growth factors and issues that we've discussed and (inaudible)of verticals. But we have no way to really predict when and how fast that would accelerate. We are seeing activity across a much, much broader set of users. We're seeing more pipeline activity from very large users, a great number than we've seen in the past, and we're certainly seeing a lot more activity at the lower end of the spectrum where we had access to smaller business primarily through our third-party distributors.

So it's unpredictable, we've set aggressive targets for ourselves. We obviously have a business plan that reflects that aggressive target. We have quotas out to the sales people, and we're off and running. But I can't really predict the future for you here, Mike, or us.

Mike Malouf – Craig-Hallum Capital

Sure, if I could just follow up a little bit. In 2009 it looks like, given the numbers that you've said, based on my calculations, that your direct sales produced new first-year orders of about $4.35 million. And then in 2010, they produced sales in new first-year orders of about $4.04 million. So it looks like the direct sales were actually down 7% for the 12 months of 2010 versus 2009, and I'm just wondering if you can comment a little bit, is there some cannibalization going on in the channel or you talk about quotas for your sales force to date, missed quotas? Or was there some - ?

Rick Spurr

Good question. The reason for that is that the way that the sales force works harmoniously with these channels. So the OEM guys stand alone – Google and MessageLabs and Web Route and the others. But the 106 now value-added resellers and managed service providers – actually, think of them as reporting up through our sales guys. So our sales guys are motivated to help them, train them, encourage them, in some cases getting them leads to create our overall coverage model and higher levels of productivity. So it's very important that you don't get them fighting against each other, you've got to get them working together to get the sorts of growth that we've experienced.

So when you see the channels go crazy like that, it's because the sales guys on the direct side are, in many cases, giving them deals and helping them achieve that growth.

Mike Malouf – Craig-Hallum Capital

Okay, great. And then one other question. I get a lot of questions about the market and about how the overall market is growing, and I'm wondering if you can just comment a little bit about what is the overall market's growth at this point as you look forward over the next year or two? Thanks.

Rick Spurr

So another one of these unpredictables, but everybody that's out there has some sort of market estimations, and there aren't many of them, but there's a couple of large third parties. They're all calling it in the 20% range, and we don't have any reason to disagree with that. We saw 25% growth year-on-year in revenue last year, but we command a pretty high price, so sometimes you'll see our revenue outpace the seat growth. But the simple answer is people are predicting 20% compounded growth rate year on year out through - even into 2015.

Mike Malouf – Craig-Hallum Capital

So I guess based on those numbers your guidance is for market share loss? Is that right?

Rick Spurr

Yeah. Our guidance is our guidance, Mike.

Mike Malouf – Craig-Hallum Capital

Okay, thanks.

Operator

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

Fred Ziegel - Blue Water Capital Markets

Hi Rick.

Rick Spurr

Hello Fred.

Fred Ziegel - Blue Water Capital Markets

Let me ask one housekeeping question. When might we get the first three quarter restatements for 2010?

Mike English

End of mid-March, early mid-March.

Rick Spurr

Probably around mid-March we should have that.

Fred Ziegel - Blue Water Capital Markets

Is that going to be with the K?

Mike English

Yes.

Fred Ziegel - Blue Water Capital Markets

Rick, what have you seen, if anything, in terms of expansion of some of the state encryption laws that have been around for a little bit now in Nevada and Washington and Massachusetts. Have there been any additional movement there?

Rick Spurr

I assume what you're asking, Fred, is any additional states?

Fred Ziegel - Blue Water Capital Markets

Right.

Rick Spurr

Yeah, all we know is that there's a lot of activity, but it's anybody's guess as to when things pop out of legislative debates into something that's meaningful. So we don't have any way to predict that, but there is activity going on in a number of states.

Fred Ziegel - Blue Water Capital Markets

Okay. On the fixed mobility what's likely to be the best channel to deliver that, if there is one over the rest of them? Or is it going to be not unlike the other services?

Rick Spurr

I don't view any difference. All of our channels deliver all of our products to all of our customers, and no, we're not believing or thinking that mobility is going to be any more advantageous to certain channels or another. It just raises the bar across the board for our competition for every single placement of our product. Now some customers are going to care more about mobility than others, but that's really a function of the sophistication of their workforce and their policies and work flows, but there's no industry or channel that would jump out at us as being particularly relevant.

Fred Ziegel - Blue Water Capital Markets

Is it phone-centric, or are we going to see tablet support I presume?

Rick Spurr

We have tablet support already in the product, so that's there as well, yes.

Fred Ziegel - Blue Water Capital Markets

Okay. Last question:what are your thoughts on the international market?

Rick Spurr

My thoughts are that it's – I always think of the international market as being double the US, but it's all chopped up into different countries and different cultures with a myriad of circumstances in each of those countries, which may provide great opportunity or no opportunity. We've talked before about heading into – investing in products such that it's easily enabled with 12 languages, including all the double-byte languages. We do have some distributors overseas. Google and Symantec continue to have access to our product for sale overseas. We are exploring distribution in Japan, but it's really too early to get any of us excited about that. We haven't reported any meaningful contract closures there. But it's on our radar.

Fred Ziegel - Blue Water Capital Markets

So likely no new data center outside the US for a while except for the one in the UK.

Rick Spurr

We aren't planning one at this time, but if we had a meaningful progress in one of these major markets, and the justification was there, we'd do what we have to do. That again was a relatively inexpensive endeavor on our part, so we'll do it if we can accelerate growth and capture a new market, but absent that, we're not going to go fishing.

Fred Ziegel - Blue Water Capital Markets

Okay, thanks.

Rick Spurr

Thank you.

Operator

Our next question comes from the line of Jackson Spears with Gar Wood Securities. Please proceed.

Jackson Spears – Gar Wood Securities

Rick, congratulations on your numbers. Could you walk us through the operating expense line, R&D and SG&A in 2011? What are your plans to expand that now that you have a lot of momentum and a focused business strategy?

Rick Spurr

I was listening, Jack, to the first part. What was the tail end of that?

Jackson Spears – Gar Wood Securities

What kind of R&D expense will be going forward, will it be like 10, 12% of revenues? What's the number, and what about SG&A line? And are you going to hire more salesmen going forward?

Rick Spurr

So when we finalized our budget and decided and authorized our expenditures, I told people previously and I reiterate here, our adds to sales and marketing our targeted and appropriate, but given the leverage we have in the top line, you won't see massive influxes of expense there. The SG&A and aggregate, Jack, for 2011, we believe will run in the 40-41% revenue range, and so I think that's slightly down, like a point, from last year if I remember. R&D we expect will be in the 13-(inaudible)% range and that's down slightly from last year on a percentage basis. We've already counted it to a certain degree on cost of goods sold. We believe it will be in the 19-21% range in terms of percentage of revenue. And that's what leads us to the operating income guidance that Mike gave in the high 20s.

Jackson Spears – Gar Wood Securities

What kind of tax rate now that you're profitable and you've had that reversal, what kind of tax rate should we assume for 2011 in our models?

Mike English

Well, Jack, on the tax rate basis -

Jackson Spears – Gar Wood Securities

On a state and federal level.

Mike English

The federal level is 35.25, but you know we have the NOLs that are out there, so they will have a definite impact on the cash taxes, they'll reduce them.

Jackson Spears – Gar Wood Securities

So on a reported basis, what assumption should we use?

Mike English

I'd use the 35.2.

Jackson Spears – Gar Wood Securities

Thank you, sir.

Operator

Ladies and gentlemen, that concludes our call for today. Thank you for your participation in today's presentation. You may all disconnect, and have a great day.

Rick Spurr

Thank you everybody. I appreciate your interest.

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