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Interactive Intelligence Group (NASDAQ:ININ)

Q4 2013 Earnings Call

January 29, 2014 4:30 pm ET

Executives

Stephen R. Head - Chief Financial Officer, Principal Accounting Officer, Senior Vice President of Finance & Administration, Treasurer and Secretary

Donald E. Brown - Co-Founder, Chairman, Chief Executive Officer and President

Analysts

Shyam Patil - Wedbush Securities Inc., Research Division

Jeffrey Van Rhee - Craig-Hallum Capital Group LLC, Research Division

Raghavan Sarathy - Dougherty & Company LLC, Research Division

Craig Nankervis - First Analysis Securities Corporation, Research Division

Michael Latimore - Northland Capital Markets, Research Division

Operator

Good day, ladies and gentlemen, thank you for standing by and welcome to the Interactive Intelligence Fourth Quarter Earnings Conference Call. [Operator Instructions] As a reminder, today's conference may be recorded. It's now my pleasure to turn the floor over to your Chief Financial Officer, Steve Head. Sir, the floor is yours.

Stephen R. Head

Thank you and good afternoon, everyone, and thank you for joining us today to review Interactive Intelligence's fourth quarter and full year 2013 financial results. With me on the call today is Don Brown, our Chairman of the Board, President and CEO. Don will begin with a high-level review of our fourth quarter and full year performance in addition to providing an update on our key initiatives. I will then review our fourth quarter and full year financial results in more detail. And Don will finish with a commentary regarding our financial outlook. We will then open the call for questions.

Please note that over the course of this conference call, we will make predictive statements about our results, performance, plans and objectives in an effort to assist you in understanding our company. The enterprise software industry, combined with the rapidly evolving uncertainties and the economic environment, make predictions challenging and problematic. These predictive statements are forward-looking statements under Federal Securities Laws. Our actual results could differ materially from the information presented during this call, and you should review the section on forward-looking statements contained in today's earnings release, as well as our 2012 Form 10-K and other public filings with the SEC, which describe factors, risks and uncertainties that could cause our actual results to differ materially. The company disclaims any obligation or undertaking to update or revise any forward-looking statement.

Also during this call, we will refer to non-GAAP financial measures. These non-GAAP results eliminate the impact of noncash stock-based compensation expense, purchase accounting related adjustments and include pro forma tax expense. Management uses these non-GAAP financial measures in analyzing the business.

With that, I'll turn the call over to Don.

Donald E. Brown

Thanks, Steve, and thanks to everybody for joining us on the call today to review our fourth quarter and full year 2013 results.

The fourth quarter capped off a phenomenal year for us. As you may recall, we started out the year hoping to grow orders about 20% and instead achieved an order growth rate of 30%. In particular, our cloud orders grew 87% over the previous year and revenues increased 34% over 2012. We feel that we accomplished our goal of establishing Interactive Intelligence as the premier vendor of high-end contact center solutions for both on-premises and cloud-based deployments.

We begin 2014 with great momentum and anticipate another year of strong order and revenue growth, of which an increasing percentage will be recurring in nature. During 2014, we expect recurring revenue, which includes both maintenance contracts and cloud-based revenues to represent about 50% of total revenues, up from 46% last year and for our cloud-based business to account for 55% to 60% of orders as compared to 50% last year and 35% in 2012.

Given the ongoing global momentum in the cloud market, we plan to continue to invest in cloud solutions and sales to extend our leadership position in order to capitalize on the growing pipeline of opportunities we're seeing around the world. As a result, we expect 2014 total order growth to be 20% or more, which is above our previous guidance and is on top of what we did in 2013, which was also more than we expected.

Taking a look at some of the summary level statistics and the financials for the fourth quarter, we won 86 new customers during the quarter compared to 67 in Q3 and 110 in the year-ago quarter. We had 15 orders that were over $1 million. This compares to 12 in the third quarter and 19 in the year-ago quarter and we had an additional 48 orders that were between $250,000 and $1 million compared to 35 in Q3 and 49 in the year-ago quarter.

The average dollar amount of new cloud-based customer orders continues to increase sequentially, rising to $836,000 in the fourth quarter compared to $796,000 in the third quarter. As expected, total orders declined year-over-year by 15%, primarily due to the comparison to last year's unbelievable fourth quarter when we received our premises-based order of over $15 million and a cloud-based order of over $5 million.

Our fourth quarter revenues were $90.8 million, up 28% compared to last year and non-GAAP operating income for the fourth quarter was $9.3 million or 10.2% of revenue leading to non-GAAP EPS of $0.26, all of which were well above expectations.

The fourth quarter contributed to another strong year for Interactive Intelligence. As I mentioned earlier, total orders for the full year 2013 increased 30%, well above our guidance. We added 316 new customers compared with 302 new customers in 2012. We closed 48 contracts of more than $1 million, up from 42 in 2012, and we closed an additional 144 contracts between $250,000 and $1 million, up approximately 24% compared to 116 in 2012.

Our cloud orders increased 87% year-over-year and comprised 50% of total orders for the year, up from 35% of total orders in 2012 and I think it was about 22% in 2011. And we booked the largest order in the history of the company. Our full year revenues were $318.2 million, up 34% year-over-year, and non-GAAP operating income for the full year was $26 million or 8.1% of revenue, contributing to non-GAAP EPS of $0.79. The growth in our cloud-related business continues to result in revenues being deferred to future quarters, which contributed to the overall growth of our unbilled future cloud revenue.

During the fourth quarter, our overall deferred revenue and unbilled contracts increased 65% on a year-over-year basis to $300 million. In addition, we continue to execute on our strategy to improve the long-term financial profile of the company as recurring revenue for the fourth quarter, which includes both maintenance contracts and cloud-based revenues, increased 25% year-over-year and was primarily driven by the 61% growth in cloud-based revenues.

From a geographic perspective, we saw a strong customer demand in orders across the Americas, Europe, Latin America and Australia. Only our smaller regions, the 2 smallest, actually, Asia and Japan, came in under expectations during the quarter. As we've stated in the past, we've seen similar quarter-to-quarter fluctuations across geographies over the past 6 quarters and expect to see growth in all the regions in 2014. There's a high level of energy and excitement in our sales organization, especially given the ongoing global momentum and dynamic product roadmap.

We remain very optimistic about our ability to continue driving strong growth due to the compelling industry drivers, our improving market position and our growing pipeline of opportunities.

From an industry perspective, while we continue to see demand for our premises-based solutions, we are benefiting from the growth of cloud-based contact center adoption, which continues to be one of the most powerful market drivers that we have seen in the 20-year history of this company. People's modes for social interaction have changed their customer service expectations and the cloud is playing a vital role in this change since it enables companies to more easily offer their customers new communications options such as web chats, text messaging, video and others.

This, combined with the benefit of redirecting IT staff to focus on products -- on projects that directly impact customer service and providing access to an increasing amount of intelligent and predictive information, will help companies further enhance their overall customer experience.

Our overall cloud mix is very strong with 50% of our full year order volume coming from the cloud. And when you look specifically at our direct business, the cloud represents 67% of total orders. We're also seeing increased partner activity with cloud and cloud orders coming from our channel partners, up about 89% year-over-year.

During the quarter, we were very pleased that our cloud offering successfully met the compliance requirements for PCI Data Security Standard 2.0 and that Interactive Intelligence received Level 1 validation, the highest level offered. We believe that the validation of our cloud offering and its compliance with the standards ensures that the company's payment network meets the industry best practices in security controls that the credit card brands have established to keep their customer data secure for digital processing, storage and transmission.

We're also excited to have recently achieved Microsoft Lync 2013 qualification in the contact center category for CIC 4.0, as well as SAP certification. This will allow us the ability to offer a comprehensive solution for both the contact center and enterprise without customers undergoing costly and time-consuming integration projects.

In addition, given the ongoing global demand and growing pipeline of our cloud-based offering, we were excited to add senior staff to enhance our cloud communications infrastructure and to continue offering our customers the best cloud deployment experience possible.

In regards to our newer cloud effort, CaaS Small Center, we again closed a small number of deals during the fourth quarter. We've seen an upward trend in average order size since the beginning of the year, and the pipeline continues to build. As a reminder, this solution is designed for contact centers with between 10 and 50 agents, a market, which we believe was underserved with many organizations being required to compromise on functionality and settle for technology that's less than optimal. We view CaaS Small Center as a natural extension of our brand. It also provides added exposure to the broader market and helps protect our business against small, disruptive competitors.

We plan to build on our leadership position by staying ahead of the curve from a technology and feature perspective. We're the only vendor to have proven scalability, reliability and functionality in a cloud offering, and we believe that it's imperative for Interactive Intelligence to maintain and extend its significant lead time advantage.

Specifically, we continue to invest in our next-generation effort that leverages modern, open source technologies and Amazon Web Services as the deployment back end. This will give us a multi-tenant solution that is ultra-easy to deploy and capable of handling the needs of both very large, as well as very small customers.

Their solution will also allow us to enter the growing market for cloud-based unified communications, as well as provide another option for contact center automation. Our fiscal 2014 guidance does not include any revenue generation from this offering, although it does reflect the ongoing investments we're making in the platform.

In summary, we're very pleased with our execution in the fourth quarter, which resulted in a strong finish for the year. During the year, we significantly extended our technology leadership position and gained market share as our investments in product development and our global sales infrastructure are paying off. We've entered 2014 with strong momentum and believe the company remains well positioned to continue gaining market share and increasing the portion of business devoted to a recurring revenue model, primarily due to the rapid growth of the cloud business. With that, let me turn the call over to Steve.

Stephen R. Head

Thanks, Don. I will provide more details on the company's fourth quarter and full year financial results. Beginning with the fourth quarter and starting with the P&L, we reported revenues of $90.8 million, up 29% compared to the fourth quarter of last year and well above our guidance. Our non-GAAP recurring revenue, which includes both maintenance contracts and cloud-based revenues was $41.5 million for the quarter, representing 46% of total revenues and was up 25% year-over-year.

Our growth from recurring revenue continues to be enhanced by the rapid growth of our cloud-based revenue, which were $10.6 million for the fourth quarter, a year-over-year increase of 61%. And we recognized increases in maintenance and support revenues resulting from the increasing installed base and premises-based customers. Product revenues for the fourth quarter of 2013 totaled $34.9 million, an increase of 28% on a year-over-year basis, and represented 38% of revenue.

During the quarter, we benefited from a stronger mix of premises-based orders and recognition of certain orders that were initially deferred in prior periods based on collectability and our acceptance criteria. As we have mentioned in the past, it only takes a handful of orders to change the mix of premises-based versus cloud. We continue to expect to see a level of quarterly variability in both the growth and mix of our revenues going forward. We received an increased dollar amount of orders from new customers and from existing customers during the quarter. The average new customer order was $485,000 in the fourth quarter of 2013, which is down from $623,000 in the fourth quarter of last year, primarily due to the large number of multimillion dollar orders in the fourth quarter of last year, now that Don had already mentioned in his remarks.

Services revenues totaled $14.4 million, an increase of 41% year-over-year, which reflects the continued increase in professional services revenues from large, direct customer engagement for both premises and cloud-based deployments.

During the fourth quarter, our partners generated 73% of on-premises orders compared to 40% in the fourth quarter of last year. The increase was primarily due to the large direct premises-based agreement we signed in the fourth quarter of 2012. While partners are becoming engaged in cloud opportunities, the majority of those are still direct. Overall, 54% of our total orders in the fourth quarter of 2013 were direct.

Geographically for the quarter, the Americas provided 76% of total orders, while EMEA was 17% and Asia Pacific was 7%. Nondirect -- non-GAAP gross margin was 64.2% in the fourth quarter compared to 69.1% during the same period last year. Non-GAAP product gross margin for the quarter was 78.4% in 2013 compared to 75.2% in the fourth quarter of 2012.

The product margin in any quarter is based on the hardware and software that is recognized as revenue in the quarter. Non-GAAP recurring revenue gross margin for the fourth quarter was 67.3% compared to 73.2% last year. The year-over-year decline was due to our cloud growth and the lower current margins on cloud operations. And non-GAAP services revenue gross margin was 21% in the fourth quarter.

Non-GAAP operating income, which excludes stock-based compensation expense and purchase accounting adjustments, was $9.3 million in the fourth quarter of 2013, or 10.2% of revenue. Our non-GAAP operating income during the fourth quarter of 2013 includes $1.8 million, of a reduction and expenses related to the capitalization of development costs for internal use software as Interactive Intelligence continues to expand its cloud offering.

Non-GAAP net income for the fourth quarter was $5.6 million or $0.26 per share based on 21.4 million fully diluted shares outstanding and that compares to $5.7 million or $0.28 per diluted share for the fourth quarter last year. Both non-GAAP operating and net income were above our expectations, primarily due to the slight shift of revenue mix towards on-premises that I mentioned earlier.

Providing summary level results on a GAAP basis, during the fourth quarter, GAAP operating income was $6.5 million and GAAP net income was $3.5 million or $0.17 per diluted share. This compares to GAAP operating income of $3.5 million and GAAP net income of $2.3 million or $0.11 per diluted share in the fourth quarter of 2012.

Turning to a quick summary of financial results for the full year of 2013, total revenues were $318.2 million. Recurring revenues, which included both maintenance contracts and subscriptions, were $147.9 million, up 25% and represented 46% of total revenue. The growth was primarily driven by the rapid growth of our cloud-based revenues, which were $34.2 million in 2013, a year-over-year increase of 55%.

For the year, product revenues were $117.7 million, an increase of 33% compared to 2012 and benefited from orders that were deferred from the prior year. Service revenue totaled $52.6 million, an increase of 73% year-over-year and reflect the continued increase in professional services revenue from large direct customer engagements.

Non-GAAP gross margin for the full year was 64.6% and non-GAAP operating income was $26 million or 8.1% of revenue, contributing to non-GAAP EPS of $0.79.

Turning to the balance sheet. As of December 31, 2013, we had $107.8 million of cash and investments compared to $95.4 million as of September 30, 2013. For the full year, we generated $27.4 million in cash flow from operations and used $20.8 million for capital expenditures and $6.1 million for capitalized internal use software. The company continues to be debt-free.

Accounts receivables, day sales outstanding at December 31, 2013, were 80 days, which compares to 87 days last year and 74 days at the end of the third quarter of 2013. Adjusted DSOs, which take into account the increase in deferred revenues were 73 days. But the DSOs at year-end reflect a substantial business that was recorded in the month of December.

Total deferred revenues as of December 13, 2013, were $116 million, an increase from $108.7 million at September 30, 2013, and up from $91.9 million as of December 31, 2012. As we continue to sign additional cloud-based contracts, we have built an amount of contracted future revenue that is not recorded. This amount totaled $184.2 million as of December 31, and was up from $89.5 million as of December 31, 2012.

Deferred revenues and subscriptions totaled $300 million at December 31, 2013, up 65% from $181.4 million 1 year earlier. And now, I'll turn the call back to Don for our outlook and closing comments.

Donald E. Brown

Thanks, Steve. Given the continuing momentum we're seeing worldwide, we believe the time is right to further invest, to extend our lead and capitalize on this tremendous multibillion-dollar market opportunity. As I mentioned earlier, we expect cloud orders to increase from 50% of our total in 2013 to 55% to 60% in 2014. We anticipate that overall orders will grow at least 20% in 2014, leading to total revenues between $365 million and $370 million or an increase of about 15%. Largely because of the mix shift toward cloud, we anticipate a non-GAAP operating margin of 1% to 3% resulting in a non-GAAP EPS of $0.15 to $0.36 on 22.5 million diluted shares.

Even though increase cloud orders push revenue out to future quarters, we believe that this is a good thing for our business and our shareholders as it further cements our leadership in the overall market for our cloud communication services and positions us for increased profitability in the future. We anticipate continued positive cash flow. As we've stated previously, our main objective is to grow orders as rapidly as we can, especially cloud orders, even if doing so decreases our apparent profitability in the short run. This is largely a continuation of the strategy we announced at the beginning of 2012 that we believe has been extremely successful leading to an almost doubling of our total orders and a quadrupling of our cloud orders over the last 2 years.

With regard to the first quarter of 2014, we are currently targeting revenue in the range of $78 million to $80 million or a year-over-year growth of 7% to 10%, due to the difficult comparison to last year's first quarter when we benefited from the partial recognition of a large contract we signed in Q4 of the previous year.

The combination of typical first quarter seasonality and increased investments is expected to lead to a non-GAAP operating margin close to breakeven. Given that it only takes a handful of orders to change the mix of on-premises versus cloud, we continue to expect to see a level of variability in both the growth and mix of our revenues.

As we've discussed in the past, there is a short-term impact from cloud-based orders because we don't recognize revenue upfront, resulting in lower near-term profitability but which leads to growth in recurring revenues, longer term. Overall, we remain very confident in both the direction and momentum of our business. We feel that we have positioned Interactive Intelligence to take advantage of the historic shift to cloud-based communications and are extending that success from the U.S. to Australia, Japan, Europe and Latin America. And as strong as our cloud solution is, we feel that our next-generation solution, which we expect to introduce later this year, has the potential to be truly disruptive, allowing us to address an even larger market and put our competitors at an even greater disadvantage.

Furthermore, we feel that we're now in a position to realize operational efficiencies that will allow us to increase the profitability of our cloud operations in 2015 and beyond. As evidenced by the many accolades we've won from Gartner, Frost & Sullivan and others, we believe that we have a very strong technology leadership position. When combined with our growing reputation, expanding global reach and increasing penetration into large accounts, we feel well-positioned for success in 2014 and beyond.

So with that, let me turn the call over to the operator for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from the line of Shyam Patil with Wedbush Securities.

Shyam Patil - Wedbush Securities Inc., Research Division

First question, Don, you talked about in your prepared remarks, the global pipeline being strong for '14. Can you talk just a little bit about where the deals are coming from, which geographies, which competitors? And then for the cloud pipeline specifically, can you talk about why the on-premise customers you're converting are looking at cloud? What kind of drivers are there?

Donald E. Brown

Well, first of all, geographically, and we're seeing business all over the place, Australia has really taking off for us. In fact, I was there just a couple of months ago for a big customer event and it's pretty wild. Have a customer event there that was nearly as big as what our global customer event was here not too long ago. I'm headed to Japan next week because the whole cloud movement has really taken off there. We had some initial successes in Latin America with cloud this year, and continue to see good momentum there. Europe is kind of spotty. It really varies by country. But in Germany, the U.K., Netherlands, we have some nice cloud wins. I mean you guys know about T-Mobile last year, our implementation has gone very well there. So we're just seeing good uptake every place around the world in terms of geographies. It's really happening because we're replacing a lot of older competitive solutions and a lot of companies are just at a point where they're looking for upgrades, they'd like to reduce the number of vendors that they're dealing with and a lot of companies just want to get out of the business of IT for anything they can. They really would like to concentrate their IT resources on the things that are truly particular to their businesses and everything else they want to move to somebody else's responsibility. And so that's why we saw, in particular, one large department chain customer, a long-standing customer last year, make a huge investment in moving to the cloud, and I think we're going to see that continue, not just in the context in a realm, but as we've seen with CRM and other areas. Cloud solutions just make a hell of a lot of sense and allow companies to concentrate on what they do best.

Stephen R. Head

Shyam, when I look at the large deals we've had in the fourth quarter, it's been a pretty continuous message over the last year, but Avaya and Cisco -- excuse me, Avaya and Nortel combination seems to be the biggest donors that we replace most often, but if I look at the large deals in the quarter, we replaced Cisco, we replaced Genesys, Aspect and just a number of different premises-based solutions.

Donald E. Brown

Yes, a lot of these companies had been very slow to move to their cloud and even the moves that they have made have been kind of clunky where they've done some acquisitions and try to stitch some things together and leaves a very confusing situation for their customers and their salespeople. So we feel like we're benefiting from that. I think the most surprising trend I saw last year that makes us especially excited about this year and beyond, is just the size of the companies we're getting involved in now. I had a meeting end of last year with a large IT company that's owned by a consortium of 500 European banks and it's a total user population of roughly 60,000 to 100,000 people. And -- now that's the sort of organization, the sort of project we really couldn't have taken on a couple of years ago. But these guys had just spent a week up and down the West Coast looking at the old guard, as well as all the newer cloud-based companies and they told us that after seeing our product line and especially our next-generation product, that they had wasted their time up to that point. So we're really getting involved with some of these large deals that we really -- we wouldn't have gotten in the door with just a couple of years ago.

Shyam Patil - Wedbush Securities Inc., Research Division

That's great. I just have a couple of quick follow-up on the financial. Steve, how should we think about the gross margin in '14. And then, I may have missed this but could you maybe say what the EPS guidance was for the year, as well as for 1Q?

Stephen R. Head

Well, the gross margins for next year, we did pretty well on, if I break them down to the various pieces, product gross margin, we did pretty well. I'd expect it to continue to be in the same sort of range, maybe not quite as good as this year, I'm just not going to be that optimistic. Maybe it will be, but we'll have to wait and see it, kind of show me to believe it will stay at that same high-margin, but in the 70s. Recurring margin will continue to drip down a little bit just because the cloud is at a lower margin and growing more rapidly than the maintenance revenue is. Professional services, I expect probably, same sort of range -- it will depend a little bit on how much we have to outsource and how many people we're adding and what that kind of drag that may provide to the margin. But no dramatic changes. The most -- the one that I can really point to is the fact that, we'll probably be -- see a continued somewhat decline in the recurring revenue margin. As far as the EPS in the first quarter or for the year, we talked about $0.15 to $0.36 for the full year on non-GAAP for 2014. As far as the first quarter, Don commented that we're looking at a breakeven, so I guess that's not very much.

Operator

Our next question will come from the line of Jeff Van Rhee with Craig-Hallum.

Jeffrey Van Rhee - Craig-Hallum Capital Group LLC, Research Division

A number of questions. First, can you just start on the sales side, where did you end out on quota reps and with the aggressive spend, how are you seeing that in terms of hiring this year?

Stephen R. Head

I think, Jeff, we ended up with 117, but we hired a number of people that started right after the start of the year and we're looking at ramping up quota carrying reps by about 25% this year. With a lot of that hiring happening in the first quarter.

Jeffrey Van Rhee - Craig-Hallum Capital Group LLC, Research Division

Okay. And then on the professional services side, where are you in capacity? I guess, asked differently, where -- what kind of utilization do you have right now? How many heads and what kind of hiring do you expect there?

Stephen R. Head

Well, I think the hiring there will probably be even faster than the overall hiring. It's been pretty strong for the last few years. We commented on the growth in professional services and that is, it's driven by a combination of both the hirers we've made plus outsourcing to some of our partners and others to perform the work. I don't know the number of heads right off the top of my head at the moment, but the number will be going up somewhat proportionately to the expected revenue increase.

Jeffrey Van Rhee - Craig-Hallum Capital Group LLC, Research Division

Any sense of utilization right now? Where you are relative to capacity?

Stephen R. Head

I think we're pretty strong. We're -- that's why we're outsourcing more and more, too. It's just because we're really utilizing the people that we have fully.

Jeffrey Van Rhee - Craig-Hallum Capital Group LLC, Research Division

Okay. And then just, I guess just back to high-level. Certainly, you've really been getting it done on the revenue growth side and ultimately that's what's going to drive the story. On the flip side of it as it relates to the margins you've had, a couple of years now where it looked like operating margins had bottomed and were gradually working their way higher as you were getting some leverage on the on demand side and sort of rebuilding off of that lower operating margin reset, if you will. And then in this guide, it looks like you've done a bit of a reset taking it back down again. In terms of when you did your annual budgeting, what was it that led you to believe just sort of a steady ramp in margins from here was not doable while still investing a lot in sales. Just walk me through your thought process in terms of the level of aggression in reinvestment.

Donald E. Brown

Yes. Well, you have to understand that a lot of that reduction in margin comes purely from the increased percentage of orders coming from cloud, right? So we're looking to go from 50% cloud orders to up to 60% cloud orders. And there's just no way to kind of blunt that impact, because we're taking that revenue and spreading that out over time and yet we're still recognizing the expenses. So even though the cash flow that's -- well, I guess, in my mind, the amount of business that we're booking is not going in the right direction. It just makes the apparent financials look worse because the revenue is trailing the expense. So part of that is an unavoidable aspect of what we consider to be success of our business. And frankly, if we get surprised and 70% of our orders come from cloud this year and knocks down our operating margin even more, we're going to be dancing in the streets. We want this, because we know that as a company, we -- long term that, that's a really central to our success, we know that valuation multiples are greater for that sort of recurring cloud revenue than they are from license revenue. So it's more than anything. It's really an impact of our success in doing more and more cloud business.

Jeffrey Van Rhee - Craig-Hallum Capital Group LLC, Research Division

Okay. I mean, I can follow-up offline, I just -- the percent of bookings from cloud have been ramping over the last couple of years and yet the margins had been gradually improving in that environment. I get you plan to have more cloud and I get how that's a good thing. I guess I just was -- without having had time to go through the numbers, wondering if there's anything else implicit in there. And then I guess just last one for me on the cloud, where are we now in terms of profitability? I'm not sure if you mentioned it, but gross margin on cloud at this point?

Stephen R. Head

Yes, Jeff. For the year, our profitability was about 30% on cloud operations, which is up a bit from last year and we're expecting to see some additional improvement this year. As I mentioned, though, it's still lower than our overall recurring revenue margin. So as a result of it growing faster, it's still going to be dragging recurring margins down somewhat. Going back to your previous question, we ended the year with about 200

[Audio Gap]

to include the management and others, but just to give you a sense of the size of the group.

Jeffrey Van Rhee - Craig-Hallum Capital Group LLC, Research Division

And no sense of, at this point, at least how many heads you might have at this year, 280 -- from the basic 280?

Stephen R. Head

It will be a significant number. I don't have that number in front of me, though, Jeff.

Operator

And our next question will come from Raghavan Sarathy from Dougherty & Company.

Raghavan Sarathy - Dougherty & Company LLC, Research Division

First question is for Don. Don, if I heard you right, you were talking about the Small Center CaaS product and you talked about using Amazon? And I think if I heard you right, you talked about it from potentially to give you the flexibility to come up with a unified communication offering. Is that going to be -- does it mean that you're going to enter the unified communication market in addition to the contact center market and the -- for the small business segment. Help me understand that.

Donald E. Brown

Well, first of all, let me explain that the next-generation offering that we're building isn't just for the small market. It's a multitenant offering, we're able to use features like Amazon's Elastic Load Balancer to handle very, very large opportunities up to 100,000 users or more. The real nice -- the thing that we like about the architectures is that since it is multitenant, it gives us the flexibility to handle customers of all different sizes on the same platform rather than the sort of single tenant cloud offering we have today where there's a certain amount of overhead that comes with every customer and because of that, it kind of limits the size customer we can handle at the lower end. So the next-generation stuff will handle a wide range of customers and, yes, we're designing it so that it offers unified communications capabilities, as well as strong contact center capabilities. To some extent, that's similar to what we do today where we have customers who purchase CIC not just for their contact center, but for their business users. With the next-generation offering though, we're taking that quite a bit further and we'll have to see exactly how quickly we push that. I'm not -- I wouldn't see us this year going out and selling a standalone UC offering, but it definitely will put us in the position to be able to do that at the point that we're ready. What it will especially do is put us in a very strong position for customers wanting to automate their contact centers and maybe being interested in using the same solution for their enterprise unified communications as for their contact center.

Stephen R. Head

And, Rag, if we look at where our current customers are in the cloud space, we look at the total seats both contact center and business users. Over 25% of those seats are business users today, so we have a lot of customers that use us for a lot more than the contact center.

Raghavan Sarathy - Dougherty & Company LLC, Research Division

Okay. And then 2 quick follow-ups, Steve. So you talked about the Professional Services Group headcount addition. So last year, you've had very strong growth and the services were only up 73%. Can you give us some color on how to think about this? And then on the margin, it seems like last year also, you kind of guided so I can't remember if it's 100 to 200 basis point margin improvement. You ended up doing much better than what you initially expected. Of course, it has a lot to do with the mix. So in your outlook margin for this year, what sort of expectation do you have for product revenue. That seems like the biggest wildcard, which I think everybody is trying to get their arms around. Why the margin are reset?

Stephen R. Head

Yes. Well, I think, the -- on the professional services, we will see continued strong growth. We're planning fairly conservatively. But if we see overall growth of 15% to 20%, professional services will grow at least that strongly with the rest of the business. If we look at the margin this year, there's a couple of things that contributed. One was the fact that we did outperform what we started saying at the beginning of the year when we talked about 20% order growth. The fact that we did 30% just means we have more premise orders along with more cloud orders given the mix is about what we'd expected it to be. So that contributed to the better performance for the full year. As far as product revenue for this next year, orders will be fairly constant. Revenue should be somewhat constant, maybe up a little bit. We do get some product that comes along with the cloud orders, that gets counted when we do the external financials as premises revenue for some of the component. So cloud -- premises orders relatively flat, maybe a little bit of an upswing in the product revenues that we report.

Operator

Our next question in the queue will come from the line of Craig Nankervis with First Analysis.

Craig Nankervis - First Analysis Securities Corporation, Research Division

A lot of my questions have been asked. I guess, maybe I'm interested to know just in terms of the revenue results for the quarter. Can you detail maybe Steve, a little bit why there is such a disparity between your results and the guidance you initially put out for the quarter? Can you just talk a little bit about what specifically happened to cause the results?

Stephen R. Head

I'll point to a couple of things, Craig. One is the fact that we did have a little bit stronger premises mix than we'd expected when we started the quarter. We thought it would be more balanced with cloud and in fact it was little heavier premises than cloud for the quarter and that contributed. We did have a little bit of revenue we picked up from the prior year. And part of that was, we had at least one large customer that we deferred based on collectibility issues in prior periods that we collected on in this quarter and were able to recognize in this quarter. Now we always have some of that going on, but all of those things contributed to this one quarter. As usual, it's not just one thing, it's a number of pieces that add up to the difference.

Craig Nankervis - First Analysis Securities Corporation, Research Division

And then just looking back. So last year, at this time last year, you provided revenue growth guidance of the low 20s, I think it was 20% to 22% growth for 2013. And you're putting out 15% growth for this year. Can you just talk about why that's the case? Is it the orders? Was it the big deal in Q4 of '12 that influenced your guidance for 2013 that is less of an influence in 2014 or just the dynamics of the difference in your initial revenue outlook for the year would be useful?

Stephen R. Head

Yes, I think at a big macro level, we had talked last year about certain opportunities we weren't able to recognize as we received them, and we expected to recognize them in 2013. And we did. So we knew we had some of that revenue coming into the year. And so it led us to being able to forecast a little bit higher based on the order of mix and everything else. The other thing is that -- we've already talked about is just as we see the shift to cloud continue, it kind of dampens the revenue growth in the short run. So as we put it all together, we're being a little more cautious on the outlook at the beginning of this year.

Operator

[Operator Instructions] And our next phone question will come from the line of Mike Latimore with Northland Capital.

Michael Latimore - Northland Capital Markets, Research Division

Steve, you mentioned the cloud market was 30% for the year or for the quarter?

Stephen R. Head

For the year.

Michael Latimore - Northland Capital Markets, Research Division

What was it in the -- do you have the number for the quarter?

Stephen R. Head

No, not specifically, Mike. I mean it doesn't change much dramatically in a short run. So it's just -- we expect to see it continue to progress, but we're adding people and a lot of things like that, that can change it a little bit quarter-to-quarter. I think the bigger trend is just if we look at the year versus where we were the year before. It's up and as we'd expected it to be and that's where we're focused on continuing to see it move.

Michael Latimore - Northland Capital Markets, Research Division

And the one big on-prem deal from the fourth quarter of '12, have you recognized all that revenue now?

Stephen R. Head

No, we still have about $3 million to go on that, that'll -- we still expect it to be over the first half of this year. So it's still got a little piece left.

Michael Latimore - Northland Capital Markets, Research Division

And how much is the average cloud deal length, the average time to deploy cloud deals? Do you have some general number or any changes there?

Stephen R. Head

No, those have been pretty constant. We're around -- average contract is around 4 years period to deploy is typically 2 to 4 months. So a number of factors that enter into that. Some of the very large engagements can take longer than that. But for the typical site engagement, it's something like 2 to 4 months.

Michael Latimore - Northland Capital Markets, Research Division

And in ordering new products, it sounds like it's all scale for the biggest, kind of anybody needs it. I guess, when you first launched it and start marketing it, how are you going to target it at any particular vertical? Or is that going to be available to all your prospects?

Donald E. Brown

It'll be available across the board. There is no particular vertical focus. Now it basically we're -- this is obviously a complex market and we feel very lucky to be able to have the 3 major deployment modes that customers are looking for, which are on-prem, single-tenant cloud and then multitenant cloud. So the new offering, it's not going to start off and have all the features we've spent 20 years building for CIC. But it will have the advantage of a more scalable architecture. So we just feel we're getting good corroboration at this point that there's a set of customers of various sizes out there who really value the rapid deployment, the ability to scale up and scale down very flexibly and don't require all the features that we have in the more complex CIC solution. So we're going to go out and target that at customers across industries. But so far, we've had very strong interest in banking, health care, government, really, across the board.

Michael Latimore - Northland Capital Markets, Research Division

So you're going to -- it sounds like you'll target small, mid and large opportunities, not just for a small mid-set?

Donald E. Brown

Absolutely.

Michael Latimore - Northland Capital Markets, Research Division

Just last question, do you have any CapEx forecast for the year, including software CapEx?

Stephen R. Head

On the traditional types of things we're buying for computer infrastructure and furniture and lease hold improvements and everything, it will be about the same as this year, about $20 million and it's really split 1/3, 1/3, 1/3 between IT infrastructure and our cloud operations and then just all the other furniture and fixtures and things that we need. As far as the capitalization of internal use software, I think that's going to depend on how the development process goes, but right now, I think we're targeting -- it will be about another $4 million or $5 million.

Operator

Our next question is a follow-up question from Mr. Sarathy.

Raghavan Sarathy - Dougherty & Company LLC, Research Division

A quick question for Steve. So you've talked about investments, so to capture the cloud opportunity, can you give us some color on whether investments are going down in sales and marketing predominantly, or R&D? I know you had some capitalization last year that may have kept the R&D growth and a little bit tapped. Can you give us some color on it?

Stephen R. Head

Sure. Well, I think as we look at it, and if we really look at -- saying margins are going to be going down, it splits into 2 pieces. One is just this cloud mix difference, which accounts for part of it. The fact that we're seeing more cloud orders that aren't being recognized currently. And then some of it is just the fact that the cloud operations and sales at this point haven't reached scale. If we look at the expenses across the board, we're looking at increasing 20% to 25% in just about all the areas of the company. So I mentioned sales, quota-carrying folks will be going up and so will, all of the other areas of the company we're increasing, spending that -- try to capture this market opportunity we have. So it's just a combination of all of those things that are going on Rag, that end up with earnings that weren't expanding at this point.

Operator

And I'd like to turn the program back over to management for any additional or closing remarks.

Donald E. Brown

Well, I guess I just want to emphasize that we are very excited about the progress that we made in 2013 and that even though we are expecting operating margins to decrease in 2014, it's because of the success that we're seeing in the cloud, by and large, as well as just what we got to do to meet the sort of order growth. We're predicting at least 20% order growth. As you might imagine, we're targeting more than that internally in terms of the targets that we give out. So we're looking forward to a really strong 2014 and beyond. Thank you, all, for listening in and we'll talk to you next time.

Operator

Thank you, presenters, and thank you, ladies and gentlemen. Again, this does conclude today's call. Thank you for your participation and have a wonderful day. Attendees, you may now all disconnect.

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