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Executives

Cassandra Hudson

David Friend - Co-Founder, Chairman, Chief Executive Officer and President

Anthony Folger - Chief Financial Officer, Principal Accounting Officer and Treasurer

Analysts

John S. DiFucci - JP Morgan Chase & Co, Research Division

Brian J. Schwartz - Oppenheimer & Co. Inc., Research Division

David E. Hynes - Canaccord Genuity, Research Division

Tim Klasell - Northland Capital Markets, Research Division

Jaimin Soni - BofA Merrill Lynch, Research Division

Ben McFadden

Carbonite (CARB) Q1 2013 Earnings Call May 2, 2013 5:00 PM ET

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Carbonite, Inc. First Quarter 2013 Earnings Conference Call. [Operator Instructions] I would like to remind everyone that this conference is being recorded. I would now like to turn the call over to Cassandra Hudson, Corporate Controller. You may begin.

Cassandra Hudson

Thank you, operator. Good afternoon, and thank you for joining us today to review Carbonite's first quarter 2013 financial results. With me on the call today are David Friend, Chief Executive Officer; and Anthony Folger, Chief Financial Officer. After prepared remarks, we will open up the call to a question-and-answer session.

During this call, we may make statements related to our business that will be considered forward-looking statements under federal securities laws. Words such as, but not limited to, plan, expect, anticipate, believe, goal, estimate, potential, may, will, might, could, target and similar words will identify forward-looking statements. These statements reflect our views only as of today and should not be relied upon as representing our views as of any subsequent date.

The statements reflecting our current views regarding the future are subject to a variety of risks and uncertainties that could cause actual results to differ materially from expectations. For a discussion of the material risks and other important factors that could affect our actual results, please refer to our SEC filings, including our annual report on Form 10-K filed with the SEC on March 6, 2013. Available on the SEC's EDGAR system and also on our website. We encourage all investors to read our SEC filings.

Carbonite expressly disclaims any obligations or undertaking to release publicly any updates or revisions to any forward-looking statements made herein, except as required by law. Additionally, non-GAAP financial measures will be discussed on this conference call. A reconciliation to the most directly comparable GAAP financial measures can be found in our press release, which is available at our website, www.carbonite.com, under the Investor Relations tab. Also please note that our webcast and today's call will be available on our website in the Investor Relations section.

With that, I'd like to turn the call over to our Chief Executive Officer, David Friend. Dave?

David Friend

Thanks, Cassandra, and I'd like to start by thanking all of you for joining us today for our first quarter 2013 earnings conference call.

This was a successful quarter at Carbonite, highlighted by solid bookings growth, especially in the Small Business market, our third consecutive quarter of positive free cash flow and our victory at trial in a patent suit brought by the patent assertion entity, Oasis Research.

Looking at the overall business and some of the strategic initiatives that are underway, I'm happy to report that we've made real progress around the 3 key business themes we discussed with you last quarter. The shift towards Small Business market, the growing importance of indirect distribution channels in reaching our customers and the development of new products that enhance our value proposition.

During the first quarter, we hit a significant milestone, passing the 50,000 Small Business subscriber mark. Small Business represented approximately 24% of our total bookings in Q1 2013, up from 14% in Q1 2012. I believe that these results further reinforce our contention that the Small Business market is ready to embrace the cloud and recognizes the many advantages of our cloud backup, including lower overall cost, administration and easy access to business files on any computer or mobile device.

It also shows that the investments we have been making are paying off. Our goal is to continue to gain market share in the Small Business backup market. We believe that our initiatives in the Small Business market will be the key growth driver in 2013, and that Small Business will represent an increasingly large share of bookings as we move through the year.

Simultaneously, we remain committed to growing our core consumer business. We continue to see the early benefits of the Zmanda acquisition and our ability to offer our Small Business customers a complete backup offering that includes robust database backup capabilities. A recent study we conducted shows that businesses are not doing a good job of backing up their production databases. Most are still backing up manually to old-fashioned tape drives, external hard drives or thumb drives. Such backups, of course, are inherently unreliable, and the manual processes themselves are time-consuming and error-prone.

25% of small businesses we surveyed reported that they've had at least one incidence of data loss. These businesses also indicated that the ability to backup production databases, particularly Microsoft SQL Server and Microsoft Exchange server, ranked high in importance when selecting a backup solution. Zmanda's legacy as a widely used and respected open-source product conveys the same sense of trustworthiness and reliability that we have cultivated for Carbonite's brand over the last 7 years. So Zmanda is turning out to be a very good fit.

As we discussed with you last quarter, stage 1 of our Zmanda integration plan was to arm our growing reseller channel with database backup for their Small Business customers. I'm pleased to say that with Carbonite Database Backup, formally Zmanda, we now offer what our resellers have been seeking for a long time, an affordable and complete backup solution from one vendor that covers laptops and PCs, mobile devices and production database servers.

Stage 2 of the Zmanda integration, which is currently in progress, includes some additional technical integration and will allow us to combine the Carbonite and Zmanda service offerings and sell as an integrated solution through our in-house direct sales team and via carbonite.com.

A second key focus has been increasing the scalability of our business by diversifying and growing our indirect distribution channels.

As a result of our efforts, we have seen ongoing strong response to our reseller program with the number of resellers increasing 56% over the last 10 months, to approximately 3,400 active resellers today. We have also seen increasing interest from large strategic partners such as big box retailers, cable companies and independent Internet service providers who are trying to push further into cloud services.

As I mentioned on our last call, Carbonite's well-known brand has proven to be a big asset in recruiting all kinds of resellers. Resellers themselves report that the Carbonite brand is widely recognized by their customers and that greatly facilitates their sales process.

We continue to believe our partners are an effective way to reach a base of customers that we cannot reach through our direct sales efforts, and we expect indirect channel sales to continue growing as a percentage of our total business. On the innovation front, we released the latest version of Zmanda's server backup products. Amanda Enterprise 3.3 delivers significant architectural and feature updates. Key enhancements in Amanda Enterprise include advanced backup management, optimized SQL Server and Exchange backups, improved virtual tape and physical tape management and expanded platform support.

We also introduced a new version of Zmanda called ZRM, which is specifically designed to back up MySQL databases and to streamline the management of multiple servers. MySQL is a leading open-source database and is widely used in both academia and business. MySQL is used in many high-profile, large-scale World Wide Web products, including Wikipedia, Google, Facebook, Twitter and YouTube.

With ZRM, instead of implementing and monitoring a MySQL backup script on each MySQL server, MySQL database administrators can centrally install and monitor backups of MySQL databases across the entire enterprise. The release of ZRM from MySQL 3.5 brings disk space and network usage optimization and enhanced backup reporting, along with simplified management to help configure backups quickly and intelligently.

Last quarter, we spoke to you about Carbonite Labs and our new syncing and sharing product called Currents, which is presently in beta. Currents continues to receive very positive customer feedback, most often related to its ease-of-use, its leverage of the cloud and its ability to streamline syncing, sharing and collaboration.

We are making further product improvements as we move towards general availability. Currents is a great example of how we continue to make things simple for the user.

On the subject of litigation, I'm thrilled to announce that Carbonite finally prevailed at trial in a patent suit brought by the patent assertion entity called Oasis Research. A Texas federal jury recently concluded that Oasis' patents were invalid. We hope that our jury trial and verdict will serve to raise awareness of the issues surrounding nonpracticing entities like Oasis.

Finally, I'd like to highlight that I'm personally excited about the positive trends we're seeing in the growth of our Small Business bookings and our ability to build out our indirect distribution channels. I'm optimistic about our strategy and our ability to deliver consistently positive results for the year.

With that, I'd like to turn the call over to Anthony Folger, Carbonite's CFO. Anthony?

Anthony Folger

Thanks, Dave, and thank you all for joining Carbonite's first quarter 2013 conference call. I'll start by providing details on our financial performance during the quarter, and then I'll discuss our financial guidance for the second quarter and full year 2013.

Overall, I'm pleased to announce solid bookings, record revenue and a third consecutive quarter of positive free cash flow.

Revenue was $24.5 million, an increase of 32% over the same period last year. Bookings were $29.3 million, an increase of 20% over the same period last year and slightly higher than the 19% growth that we reported in both the third and fourth quarters of 2012.

As I said on our Q4 earnings call, we felt that the 19% bookings growth that we experienced during Q4 2012 was the bottom, and our Q1 2013 results reinforce that belief. We continue to expect a gradual bookings acceleration from Q1 levels, driven by the positive trends in Small Business as we move through 2013.

During the first quarter, Small Business bookings were 24% of total bookings, up from 14% in the first quarter of 2012. This shift reflects the progress we are making in our transition from being primarily a consumer online backup company, to one that is more focused on the Small Business market, leveraging both direct and indirect distribution channels.

Customer retention for the quarter remains strong and in line with our historical averages of 96% to 97%. And as a result, total customers at the end of the quarter were 1,471,000, compared to 1,279,000 in the same period last year.

We ended the quarter with just over 50,000 Small Business customers, and believe this is a significant milestone as we continue to shift our efforts towards the largely untapped Small Business cloud backup opportunity.

Now let's turn to costs and margins. Before I begin, I'd like to highlight that all of the financial figures I will discuss today are non-GAAP, unless I state that the measure is a GAAP number. A GAAP to non-GAAP reconciliation can be found in the tables of our press release, which is available on our website.

Gross profit for the first quarter was $15.9 million, representing a gross margin of 65% compared to a 64% gross margin in the same period last year. As mentioned on our Q4 call, we have seen some cost of revenue increases associated with some of our recent product launches and the integration of acquisitions.

Additionally, our gross profit was negatively impacted by higher than expected employee benefit costs in the quarter. We expect all of these costs to normalize over the course of the year and expect our current gross margin levels to expand.

Operating expenses totaled $20.6 million in the first quarter compared to $18.6 million in the same period last year.

Looking into the components. Research and development expenses were $5.2 million or 21% of revenue, compared to $4.5 million or 25% of revenue in the same period last year. Our research and development efforts continue to focus on new innovative solutions targeted towards small businesses and tighter integration of our database backup offerings.

Sales and marketing expenses were $12.3 million or 50% of revenue, compared to $12.4 million or 67% of revenue in the same period last year. The slight reduction in sales and marketing expenses and resulting operating leverage is a reflection of our shift in focus from consumers to small businesses and the initiatives we've got underway, which we believe will allow us to more effectively reach these target customers.

General and administrative expenses were $2.9 million or 12% of revenue, compared to $1.7 million or 9% of revenue in the same period last year. The increase year-over-year is due principally to additional personnel and professional service costs associated with supporting our overall growth and the increased administrative requirements of operating as a public company.

Non-GAAP net loss improved to a loss of $4.7 million this quarter, compared to a loss of $6.7 million in the same period last year. Our non-GAAP net loss excludes $1.3 million of stock-based compensation expense, $1.2 million of patent litigation expense, and $264,000 from the amortization of intangible assets.

Our non-GAAP net loss per common share was $0.18 this quarter. This compares to a non-GAAP net loss of $0.27 in the first quarter of 2012. On a GAAP basis, our net loss was $7.4 million or $0.29 per common share this quarter, an improvement compared to a loss of $9.1 million or $0.36 per common share in the same period last year.

Cash flow provided by operations for the quarter on a GAAP basis was $3.8 million compared to $145,000 in the same period last year. CapEx for the first quarter was $3.1 million compared to $4.9 million in Q1 of 2012.

Free cash flow was $654,000, inclusive of $563,000 in payments made for patent litigation costs that were not considered in our free cash flow guidance. Without these extraordinary legal expenses, free cash flow would have been approximately $1.2 million. This compares to a free cash flow burn of $4.6 million in the same period last year.

Our cash, cash equivalents and short-term investments totaled $56.5 million compared to $55.3 million as of December 31, 2012.

Now let's move to the second quarter and full year 2013 guidance. Starting with the second quarter, we expect total revenue to be in the range of $25.7 million to $25.9 million, and non-GAAP net loss per common share to be in the range of $0.10 to $0.12.

For the full year 2013, our guidance remains unchanged, and we expect total revenue to be in the range of $104 million to $106 million, and non-GAAP net loss per common share to be in the range of $0.40 to $0.44. Carbonite's expectations for non-GAAP net loss per common share for the second quarter and full year excludes stock-based compensation expense, patent litigation expense and amortization expense on intangible assets and assume a tax rate of 0, and weighted average shares outstanding of approximately 25.9 million and 26 million, respectively.

Our expectation remains that we will be free cash flow breakeven to positive every quarter in 2013, excluding the cash impact of onetime items such as non-GAAP adjustments for patent litigation and the potential cash impact associated with the lease abandonment of our Boston data center, which we previously disclosed.

Looking at CapEx, our guidance remains consistent and we currently estimate full year 2013 spend to be approximately in line with 2012.

Overall, we believe we are well-positioned to capitalize on the large cloud backup opportunity for small business and consumers and look forward to continued success during the remainder of 2013.

Operator, I think we're ready to begin the Q&A session. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question will come from John DiFucci with JPMorgan.

John S. DiFucci - JP Morgan Chase & Co, Research Division

I guess I have a couple of questions. The first one is the number of subs. I just want to make sure I'm clear on this, David and Anthony. We back into new subs somewhere around 90,000, which is down slightly from last quarter. Is this due to the -- which I would -- it sounds like successful emphasis that you have now on the SMB customer, and I believe, in SMB, I just want to be clear in this, is accounted as 1 subscriber. Or is there something else happening in here like have consumer subs declined or both happening, both of those things happening?

Anthony Folger

No, John. It's Anthony here and the math that you're backing into is, I think, is about right. We are seeing good success on the small business side and the small businesses are accounted as 1 sub. So there may be multiple devices. There may be a significant amount of incremental storage that a small business pays for. But that only triggers 1 additional sub for us. So as we sort of look at acquisition of new subs, we're also looking at the average revenue per user and the deal size and how that moves up as well.

John S. DiFucci - JP Morgan Chase & Co, Research Division

Okay. And are you seeing any changes in the consumer subs? I know you've had more of an emphasis on the SMB subs. But you continue to emphasize -- I mean, you haven't abandoned consumer by any means. So -- but have you seen any changes in sort of the growth of new subs there?

Anthony Folger

No, I think consumer largely performed as expected in terms of new sub acquisition. And I think SMB had a strong quarter, probably slightly stronger than expected in terms of our new sub acquisition.

John S. DiFucci - JP Morgan Chase & Co, Research Division

Okay. Great. And if I might ask a question on distribution channels, and especially the Comcast relationship. Can you tell us, even, I don't know, any detail at all, how these deals might be constructed? Like for Comcast, obviously, this gives you access to a huge potential subscriber base. But I assume you'd see some price degradation with that, too?

Anthony Folger

Yes, I think that's right, John. There is potentially some price degradation. But because of the addressable market that they bring to us, they're certainly very interesting deals and strategic deals for us. Dealing with large companies like this, I think we were happy that these deals went live, both Staples and Comcast in Q1. And we're happy that they actually went live probably a little bit quicker than we thought they would go live. But that's the first step. Now getting these relationships to the point where they're really optimized and producing as we'd like them to produce is a joint effort, and we continue to work with all the partners through the year. I'll tell you that in terms of our model and in terms of our outlook, we hadn't expected a material contribution in Q1 from these relationships. And we really wouldn't look for significant contributions until later this year.

Operator

Our next question will come from Brian Schwartz from Oppenheimer.

Brian J. Schwartz - Oppenheimer & Co. Inc., Research Division

David, wanted to see if you could maybe update us or compare and contrast how you're thinking about the sales cycles and thinking about the deal sizes between these SMB customers and consumer customers?

David Friend

Well, the Small Business consumer, as you know, is all completely direct or almost completely direct. We have some channel distribution there like Staples. But for the most part, people come to our website, put in their credit card and that's the extent of the sales cycle. A great deal of our Small Business sales are the same sort of thing, people come to our -- a small business comes to our website, signs up and tries it. But increasingly, and this is my desire as well, move that business through VARs because VARs and resellers have a lot more reach into the Small Business market than we can hope for through direct marketing. And in that case, it's really -- I wouldn't call it a sales cycle because it's still very, very short, but it's the VAR working with his customer to get Carbonite installed. So we're not really that involved in it. It's not like we have a direct sales force that's out there roaming around working on that like an enterprise deal where it might take 6 months or 1 year to close the business.

Brian J. Schwartz - Oppenheimer & Co. Inc., Research Division

And if I could just kind of follow-up on that topic or really with John's question about the indirect channel and these resellers. It certainly sounds exciting, you're signing up a lot, a lot about -- a lot of new ones. Is it possible to update us on maybe what percentage of revenues currently coming from those indirect channels or maybe where you see the percentage of revenue, revenue mix coming from the channel over the next several quarters we can just keep track of the progress of that distribution system?

Anthony Folger

Yes, hey, Brian, it's Anthony. I think we haven't really guided on that in the past. And I think where we're starting to see some good traction in this space. And to Dave's point, we expect that a lot of the growth that comes from Small Business is going to be through indirect channels going forward. I think until we have a better feel for it and until we feel more comfortable sort of projecting the growth and the mix that's to come, we're just a little bit reluctant to guide on that.

Brian J. Schwartz - Oppenheimer & Co. Inc., Research Division

Fair enough. And then, David, I wanted to ask you a question about the Currents, about Carbonite Labs. Appreciate the update on that. Do you have any sense in terms of a timeline of when these -- the Currents products could be in beta testing or maybe when you think it might even be in production or released out to the market?

David Friend

It's in beta now. So you can go to labs.carbonite.com, and sign up and become a beta customer. And I would say we're getting near to production. The feature and bug list is getting shorter and shorter. I can't tell you exactly when, but I think the product managers are feeling pretty good about the product now. So I don't think it'll be too long before it's in production. The customers we have who are using it are pretty happy with the product. It solves a very important use case of syncing and sharing in a way that's different and, I think, very elegant compared to sort of the simple folder-sharing products that are in the market today. And I think it'll be a real benefit to anybody who's part of the sort of Carbonite ecosystem.

Brian J. Schwartz - Oppenheimer & Co. Inc., Research Division

And last question from me and I'll hop back in the queue. I just wanted to make sure I heard this correctly on your comments. I thought in terms of the sales and marketing spent in the quarter, a little bit less than what I had modeled, did you make a comment that you potentially held back a little bit on a program? And I guess the question would be is that, is that program or any spend that you held back planning to be used to -- as a lead generation tool here in the upcoming quarters?

Anthony Folger

No, I don't think there were any holdbacks during the quarter, Brian. We -- and I think we executed the plan and the discussion we had on our Q4 call was really about keeping our media spend flat for the year, and that's still our expectation. And so it was really about a little bit of a shift in focus from consumer to small business but still executing and spending to plan.

David Friend

Yes, I think the long-term trend will be that media will become a smaller and smaller percentage of our total revenue.

Operator

And our next question will come from Richard Davis from Canaccord.

David E. Hynes - Canaccord Genuity, Research Division

It's DJ on the call for Richard. So I don't know if it's better for David or Anthony, but can you talk us through the customer level economics of an SMB customer and how that compares to a consumer customer? Does one get to breakeven faster? How the support cost compare? I don't know if it's too early but do you have a feel for duration of relationships, customer lifetime value, that sort of stuff? It would be helpful to get a comparison between the 2 customer channels.

Anthony Folger

Sure, DJ. It's Anthony here. Lifetime value is something we look at on a fairly regular basis across business lines. We -- internally, we do know that small businesses have a higher lifetime value. Number one, the retention rates in that line of business have been slightly higher than on the consumer side. Having said that, it's still a bit immature for us. I mean, we're 18 months into these new product offerings but the retention rates look good. We do feel that the support costs over time are going to be lower, slightly lower than what we've seen on the consumer side. And in terms of the storage costs, the entire pricing model on the Small Business side is really built to take advantage of growth in data and to charge for storage that folks are using. And so there are no unlimited offerings on the Small Business side, whereas on the consumer side, we do have the unlimited offerings. And so for a lot of those reasons, we've got a significantly higher lifetime value on the small business side that we've seen on the consumer side.

David E. Hynes - Canaccord Genuity, Research Division

Does one get to breakeven faster?

Anthony Folger

Yes, Small Business gets to breakeven a lot faster.

David E. Hynes - Canaccord Genuity, Research Division

Okay. That's what I figured. And then maybe in terms of website traffic, the split between consumer and Small Business, is it comparable with the bookings mix or is the website largely a consumer sales tool? And I guess, is there anything you can read into what you're seeing in terms of that mix on the site in terms of predictions for kind of bookings mix going forward?

Anthony Folger

No, I think, the Web traffic has been fairly consistent in terms of the mix by line of business over time. We have seen -- we try a lot of different things in terms of media and what we do to drive traffic to the website. And so our media channels may vary over time, and it may drive more or less overall traffic. And that traffic may have a better or lower conversion rate depending on what we're trying to target and what we're spending. But overall, I think, by line of business, it's been generally consistent, and we've seen an okay rise in the traffic to the site.

David E. Hynes - Canaccord Genuity, Research Division

Okay. And then one on the model, I guess. The jump in G&A we saw sequentially, I mean, even when you we back out the litigation expense, it was higher than we had been modeling. I guess, is this level kind of the new norm or is there any onetime thing in there where G&A might normalize to a lower level going forward?

Anthony Folger

Well, I think, there were absolutely some investments. So we added staff over -- when you look at it on a year-over-year basis, obviously, we're adding staff over the course of 2012. We were required to be SOX-compliant by the end of 2012, which we were. So there are some additional costs associated with being a public company also additional costs to support the growth of the business. So there was, and will be going forward, maybe a slight bump in terms of what you might have historically modeled. But there was also a onetime charge in G&A this quarter for a sales tax accrual. And I think, like most companies with our business model, assessing sales tax is sort of an ongoing process. And occasionally, we may book an accrual where we think we may have some tax liability to cover back tax, and we've done that in the quarter and are sort of moving forward. So we don't expect those types of things to repeat but the sales tax accrual was a little north of $300,000.

Operator

And next, we'll go to Tim Klasell from Northland Securities.

Tim Klasell - Northland Capital Markets, Research Division

Real quickly, you touched briefly on the renewal rates for the SMB being better than the consumer. I know these have a little more history, you've got some more customers. Can you give us a little bit more detail or color on that, I don't know if you can share the numbers or maybe something to give us a feel that the move into to the SMB is -- you got stickier customers in there?

Anthony Folger

Sure, Tim. It's Anthony here. I think, we've -- it's still early for the SMB, as we said. We've had the offerings out there for more or less 18 months. We've had strong renewal rates, strong retention rates. The renewals have run on a blended basis around 82% over time. And we do see the small businesses coming in probably a couple of points higher than that

[Audio Gap]

So we think it's a -- we may have better stick on the SMB side, but the jury is still out to a certain extent, we want to see this prove out for a few more quarters.

Tim Klasell - Northland Capital Markets, Research Division

Okay. Good. And then if I remember right, last quarter, it was Q4, obviously, you had about 30% of your bookings coming from the SMB and that's down sequentially. Do you think there's going to be more seasonality in the business as the SMB portion of your customer base picks up? Should we start expecting stronger Q4s or some potentially maybe a little bit lighter Q1 going forward on the bookings side?

Anthony Folger

No, I think with SMB as a percentage of total bookings for Q4, we ran about 27%. And for Q1, we're at 24%. And you've got to remember that in Q4, there's a bit of seasonality because we've got high concentration of renewals for small businesses in that time. We're pleased with the percentage of bookings that came from SMB. I would say it exceeded our expectations for Q1. And at this point, I think that line of business is still experiencing the type of growth where we expect to see continual gradual acceleration or growth in Small Business as a percentage of total bookings.

Tim Klasell - Northland Capital Markets, Research Division

Okay. Good. And then one final one. On the consumer side, in the past, you sort of mentioned that maybe you had saturated or optimized the spend on the media channel to go after the consumer. Do you still think you're there or do you think maybe you want to reduce that? Or do you want to expand that? How do you feel where you're spending on media sits right now for the consumer?

David Friend

This is Dave here. We're just starting to get a feel for how to direct our media spend between the consumer and Small Business. And it's really too early to say exactly where it's going to end up. But I think, overall, we see the company moving more towards a channel distribution strategy as a percentage of revenue, rather than entirely driven by the large media spends. So I think you've seen a fairly significant decline in media costs from Q4 to Q1, and -- or total marketing expense from Q4 to Q1 and from last year to this year, Q1 over Q1. And I think you'll see that continue overall during the course of the year, as more and more of our business moves through channel, rather than being driven directly to the website. And that's primarily because the channel has a greater reach. If you think about a small business, a doctor's office or a dentist's office, and so forth, the VARs who take care of those kinds of small businesses are really the gatekeepers for bringing in new technology. And it's much more efficient to get those guys motivated to go in and say, "You know, the way we're doing backup in this office today is pretty old-fashioned and not very reliable and it's expensive. And I'm going to switch you out and we're going to put Carbonite in here." And no amount of -- I mean, the advertising is great because it creates awareness, and the doctor or the dentist might say, "Oh, sure, I've heard of Carbonite. I see their ads on TV." It gives them comfort. But it's actually the VAR and the reseller who's going to make the sale actually happen. So over time, I think that's going to be increasingly the focus of our spending.

Operator

And now we'll go to Jaimin Soni from Bank of America Merrill Lynch.

Jaimin Soni - BofA Merrill Lynch, Research Division

Just a couple of quick questions here. When we look at the gross margins, stayed at 65% this quarter, that dipped a little bit from last quarter and after growing throughout the year last year. Are there any things that drove that dip in gross margins this quarter? And secondly, when I think about this mix shift towards SMB through the rest of the year and going forward, I'd assume, how should that impact the profitability from a free cash flow perspective, overall profitability? How should we think about the leverage that comes from this mix shift?

Anthony Folger

Sure. It's Anthony here. I think, first, on the gross margin question. On a year-over-year basis, we see a bit of expansion. But sequentially, we see a bit of a drop. And I think the real reasons for that are some of the new product offerings that we put out recently that will run on a third-party back end, as well as some of the acquisitions that we've done. Historically, we've had products that are running on a third-party back end. And that's one element of it. Another element is we're investing in new systems around our customer support organization. And we also took a onetime hit in Q1 related to benefit cost, and it really affected our support organization, probably disproportionately to the others. And so all of those things had a bit of an impact on the margin in Q1. And our plan certainly is to migrate some of the new product offerings and offerings that we've acquired onto our back-end infrastructure over time. And we wouldn't expect to have any additional benefit issues going forward, nor are we making significant investments in systems. So while all those things are present in Q1, I would expect, over the course of the year, those normalize, and we will see expansion in the margin. I don't think it's going to be quite the same level that we saw last year in terms of expansion, but there will be gradual expansion throughout the year. I think, on the second question regarding SMBs, certainly, there is a bit of a hit in terms of the channel margin that we're giving up. That can range depending on the relationship and depending on specifically which channel we're working through. Some of them are more heavily negotiated and some of them were -- where we're looking at volume reseller agreements, they're on standard paper. And so understanding the mix between some of the larger, more heavily negotiated strategic relationships and the volume relationships can -- it can impact things more one way or another. But we're recording the revenue net, and so you may see between a 15% and 25% discount given up to the channel on those deals. So as the mix shifts more to the indirect side, you can certainly expect to see a bit of a hit because of the margin we're giving up. Overall, I would say, however, it's -- in terms of free cash flow and profitability, we expect to be able to generate more volume through those channels. And over time, we expect we're going to be less dependent on big media spend to acquire customers. And so net-net, from a free cash flow standpoint and profitability standpoint, we think we'll come out pretty far ahead.

Jaimin Soni - BofA Merrill Lynch, Research Division

Okay. And one question for David. David, when you look at the competitive environment, has anything changed from your perspective on the consumer and SMB side or is it still the usual players?

David Friend

No, there really -- I wouldn't say there's any change in the competitive environment. It remains the same. I think we're finding the small business area is probably less competition than consumer. And the price advantage that we have in the small business market is pretty dramatic, whereas in the consumer business, most of the competitors are pricing pretty close. So it's -- if you go on our website, there's a comparison of Carbonite small business pricing compared with some of our competitors. And you can see that there's a pretty dramatic price advantage for Carbonite in that market. So we're finding that, that's actually a less competitive space for us than the consumer market.

Operator

[Operator Instructions] And our next question will come from Rob Owens from Pacific Crest Securities.

Ben McFadden

This is Ben McFadden calling in for Rob. I was just wondering, on the previous call, I believe you said that you expect the Small Business product line should account for 50% of new bookings by the end of the year. Is that still how you're looking at that business?

David Friend

Yes, I'll let Anthony address that.

Anthony Folger

Sure. Yes, I think, as we look out to the year, and I mentioned we're going to continue to see a pretty gradual increase in Small Business bookings as a percentage of total bookings, and I do think that as we exit the year, we're going to be expecting Small Business bookings to be close to 50% of new bookings. So you might be looking at some point in 2014 where Small Business bookings overtake consumer on new business.

Ben McFadden

Sure. Great. And if you could just give us an update on the traction that you're seeing with the mobile product and if you have anything to share regarding how mobile customers are upgrading to premium products?

David Friend

Well, as you know, that we don't charge for the mobile products, and so we obviously don't break out any of the numbers compared to that. But I guess all I can really tell you is, anecdotally, the mobile products are very popular with our customer base. It's not a major on-ramp to Carbonite but it's a very attractive reason why people buy into the whole Carbonite ecosystem.

Operator

And at this time, we have no further questions in the queue. And I'd like to turn the call back over to David Friend for any additional or closing remarks.

David Friend

Well, thank you. I want to thank everybody for being on the call today. And particularly, I want to thank the Carbonite team that worked extremely hard during the quarter to achieve a significant growth in both top line and free cash flow. And I want to thank you, all, again today for attending our conference call. All right.

Operator

And that does conclude our conference for today. Thank you for your participation. You may now disconnect.

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