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Carbonite (NASDAQ:CARB)

Q4 2013 Earnings Call

January 30, 2014 8:30 am ET

Executives

Emily Walt

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

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

Analysts

Bhavan Suri - William Blair & Company L.L.C., Research Division

Ben Z. Rose - Battle Road Research Ltd.

Richard H. Davis - Canaccord Genuity, Research Division

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

Tim Klasell - Northland Capital Markets, Research Division

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

Rob D. Owens - Pacific Crest Securities, Inc., Research Division

Operator

Good day, ladies and gentlemen, and thank you for standing by, and welcome to the Carbonite Fourth Quarter 2013 Earnings Results Conference Call. [Operator Instructions] As a reminder, today's call may be recorded.

It's now my pleasure to turn the floor over to Emily Walt, Director of Investor Relations. Ma'am, you may begin when ready.

Emily Walt

Thank you, operator. Good morning, and thank you for joining us today to review Carbonite's fourth 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, should, believe, target, goal, estimate, may, might, could 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. These 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 reference our annual report on Form 10-K for the fiscal year ended December 31, 2012, filed with the SEC, which is available on www.sec.gov or on our website, under the Investor Relations section.

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. Reconciliation to the most directly comparable GAAP financial measures can be found in our press release, which is available on our website, www.carbonite.com, under the Investor Relations section.

Also, please note that our webcast and a recording of today's call will be available on our website.

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

David Friend

Thanks, Emily. And I'd like to start by thanking all of you for joining us today.

In the fourth quarter of 2013, we again achieved record levels of revenue and free cash flow. This was our second consecutive quarter of profitability and the sixth consecutive quarter of positive free cash flow. I'd like to express my thanks to all the employees of Carbonite who made this progress possible.

During Q4, we continued to see the benefits of our strategy of focusing on the SMB market. Total revenue and free cash flow grew to record levels, demonstrating that our strategy is working. In the short time that we have been in the SMB market, it has already expanded to a $32 million business within Carbonite that grew over 70% last year. The higher average order value, higher margins and superior return on marketing investments in the SMB space continue to benefit both our top and bottom lines, as Q4 demonstrated.

Overall bookings for the fourth quarter grew 15%, with consumer growing 5% and small business bookings increasing 40% year-over-year. The Q4 growth in SMB was mostly based on sales of our endpoint backup service, the same product we've been selling to the SMB market for the last 2 years. On an annual basis, 2013 total bookings grew 18%, with consumer growing 5% and SMB growing approximately 70%.

From a product perspective, we launched our standalone server backup product at the same time as our new website on January 8. Also, in December, we hosted a webinar introducing the business continuity appliance to the channel community, with hundreds of VARs in attendance. We received the valuable feedback from the webinar attendees, and in order to have the most successful launch, we've decided to take the time to incorporate some of this feedback into the product before launching it in Q2.

As I previously mentioned, the growth in SMB was driven by the sales of our endpoint backup service. We sold our server backup product only as an add-on through the end of 2013. We now have the ability to sell it as a standalone service with the recent launch of our new website. The overall response to server backup has been strong. And we know that customers place a high priority on server backup, so we look forward to seeing the results of adding server backup to our product lineup. We believe Carbonite's server backup has a highly differentiated position in the backup market. It is one of the first of a new generation of hybrid backup services that combines the speed and convenience of local backup with the ultimate safety and accessibility of cloud backup. We know that SMBs like cloud backup as protection against major disasters like fire and flood, but we also know that they do not want to give up their local backups because backing up and recovering locally is far faster than backing up or recovering from the cloud. While many of the traditional online backup competitors sell only cloud backup, Carbonite is one of the first to combine both local and cloud backup and restore capabilities in one easy-to-install solution.

Our investments in 2013 have enabled a strong start to our transition to an SMB-focused company. In 2014, we will reinvest in areas that will support our growth long term, specifically our channel strategy, international expansion and investment in our infrastructure and R&D.

Now I'd like to talk about the channel. At the same time we are transitioning from a consumer-oriented company to an SMB-oriented company, we are also making major changes in our sales and distribution strategy. Historically, Carbonite has been primarily a direct marketing company. Over the past year, we have been moving to a channel-driven strategy. VARs; MSPs and other resellers are major influencers in the purchasing decisions of most SMBs and they are key to our reaching over 6 million SMBs we believe are in our target market. In 2013, we added over 1,500 resellers, ending the year with over 4,300. We are investing in systems and people to continue building our channel organization and to increase the sell-through rate of existing partners.

The investments we are making in channel also position us for our next investment priority, international expansion. Using trusted channel partners in markets outside the U.S. will be a great first step in bringing Carbonite SMB solutions to new markets.

In 2014, we will also continue to invest in infrastructure to support growth. We expect to move the company into new headquarters in downtown Boston during the second half of the year. We also expect to open a new data center in a relatively low-cost location and exit a data center that is no longer competitive from a cost standpoint. Finally, we plan to make additional investments in technical talent in support of our new product initiatives, particularly our appliance line.

Our proven ability to build easy-to-use, affordable and reliable products, coupled with our widely known brand, puts us in a good position to capitalize on the wide open opportunities for us in the SMB market. Combined with our increasingly strong financial position, I believe we have everything we need for years of profitable growth.

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

Anthony Folger

Thanks, Dave. Good morning, everyone, and thanks for joining us.

2013 was a year of transition for Carbonite, beginning to set the stage for where we want to go next, a leading provider of business continuity solutions for SMBs. Despite some of the challenges we've experienced in the consumer space, we're happy with the traction we've gained in the SMB space, the positioning of our current product lineup and our improved financial profile as a result of having begun this transition.

In the fourth quarter, total bookings increased 15% year-over-year to $31.6 million, reflecting 40% growth in small business bookings, combined with 5% growth in consumer bookings, when compared to the same quarter last year. Small business bookings accounted for 33% of total bookings and nearly 1/2 of all new bookings during the quarter, achieving a goal that we set for ourselves at the beginning of 2013. These results were driven by the continued success of our endpoint backup product, the introduction and early success of our server backup product and our ability to provide business service agreements for HIPAA compliance.

Our full year results echoed the performance we saw in the fourth quarter as total bookings increased 18% year-over-year to $116 million. Of the $116 million in total bookings, small business bookings were approximately $32 million, reflecting 72% growth over last year and representing 27% of total bookings, up from 19% in 2012.

Customer retention for the quarter remained strong, coming in at the low end of our historical average of 96% to 97%. During the quarter, customer retention was negatively impacted by one of our partner relationships focused on the consumer business. Excluding retention activity for this one partner, our retention rates would have trended to the high end of our historical range, reflecting what we believe to be underlying improvement in our core customer retention activities. Total customers at the end of the quarter were 1,513,000 compared to 1,431,000 in the same period last year.

Turning now to the income statement. All 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.

Revenue for the quarter was $28.8 million, representing an increase of 22% over the same quarter last year. For the full year 2013, revenue was $107.2 million, an increase of 28% over 2012.

Gross profit for the fourth quarter was $20.3 million, resulting in a gross margin of 70.5%, a 370 basis point improvement over our gross margin of 66.8% in the same quarter last year. For 2013, gross profit was $73.3 million, resulting in a gross margin of 68.4%, a 220 basis point improvement over our gross margin of 66.2% in 2012. Our gross margin improvement continues to be driven by sales growth and higher-margin SMB products, coupled with lower storage costs and operating efficiencies realized in our data centers.

Operating expenses totaled $18.6 million in the fourth quarter compared to $16.1 million in the same period last year. The increased spending is primarily due to investments that we've made in transitioning our go-to-market efforts from direct-to-consumer marketing to an SMB-focused, channel-oriented go-to-market strategy. For the full year, operating expenses were $76.4 million compared to $67.3 million in 2012.

Research and development expenses were $5 million or 18% of revenue compared to $4.8 million or 20% of revenue in the same period last year. For the full year, research and development expenses were $20 million or 19% of revenue compared to $18.7 million or 22% of revenue in the same period last year. The increased spend reflects our focus on delivering products and services that solve problems for and meet the needs of small businesses.

Sales and marketing expenses were $11.1 million or 39% of revenue compared to $9.6 million or 41% of revenue in the same period last year. For the full year, sales and marketing expenses were $46 million or 43% of revenue compared to $41.7 million or 50% of revenue in the same period last year. Our increased spend reflects investments made in our SMB go-to-market strategy, including the redesign of our website and increased spend on marketing activities aimed at SMBs.

General and administrative expenses were $2.4 million or 8% of revenue compared to $1.6 million or 7% of revenue in the same period last year. For the full year, general and administrative expenses were $10.2 million or 10% of revenue compared to $6.7 million or 8% of revenue in the same period last year. Our increased spend largely reflects increased headcount necessary to support our overall growth.

Overall, I'm pleased that we've realized significant leverage in our operating model while at the same time making meaningful investments in product development and the transition of our go-to-market approach.

In terms of bottom line. Non-GAAP net income was $1.7 million this quarter or $0.06 per share compared to a loss of $278,000 or $0.01 per share in the same period last year. For the full year, non-GAAP net loss was $3.2 million or $0.12 per share compared to a loss of $11.7 million or $0.46 per share in 2012.

Non-GAAP net earnings for the fourth quarter excludes $1.1 million of stock-based compensation expense and $226,000 from the amortization of intangible assets. For the full year, non-GAAP net loss excludes $4.8 million in stock-based compensation expense, $1.6 million in patent litigation defense costs, $107,000 from a lease exit charge and $918,000 from the amortization of intangibles.

Cash flow provided by operations for the quarter on a GAAP basis was $4.8 million, a decrease from $5.3 million in the year-ago quarter.

CapEx for the fourth quarter was $2.5 million compared to $3.2 million in the year-ago quarter, with reduced spending levels largely reflecting the storage efficiencies I mentioned earlier.

Free cash flow was $2.8 million, excluding a $500,000 payment associated with the termination of a data center lease, compared to $2.1 million in the year-ago quarter. Our cash, cash equivalents and short-term investments totaled $65.4 million compared to $55.3 million as of December 31, 2012.

Cash flow provided by operations for the year on a GAAP basis was $14.3 million, an increase from $9.2 million in 2012. CapEx for the full year was $9.5 million compared to $13.4 million in 2012.

Free cash flow for the year was $6 million, excluding $1.1 million of cash paid associated with the termination of a data center lease. Included in our free cash flow of $6 million is $2.3 million of cash paid for patent litigation, which have been expensed in prior periods. This compares to negative free cash flow of $4.1 million in 2012, which included $1.1 million of cash paid for patent litigation.

Now turning to our business outlook for 2014. Consistent with 2013, we expect 2014 bookings growth to be driven largely by bookings growth of our SMB products. As mentioned previously, small business bookings totaled approximately $32 million in 2013, representing 72% growth over 2012. In 2014, we expect the growth rate on SMB bookings to be in the range of 40% to 50% for the full year, driven largely by new product offerings targeting SMBs and the continued expansion of our distribution capabilities. On the consumer side, although we've previously communicated and expected growth rate ranging from high single to low double digits, we're lowering our outlook to be in the range of flat to low single-digit growth. Along with our revised outlook on consumer bookings growth, we will also redeploy dollars that otherwise would have been spent on media to drive new consumer subscribers into domestic and international channel expansion and product engineering resources.

Starting with the first quarter, we expect revenue to be in the range of $28.3 million to $28.7 million and non-GAAP net loss to be in the range of $0.03 to $0.05 per share. For the full year 2014, we expect revenues to be in the range of $120.8 million to $122.8 million and non-GAAP net loss to be in the range of $0.10 to $0.16 per share.

We expect gross margin for the full year to be relatively flat compared to 2013 as we make a onetime investment in the first half of 2014 to spin-up a new data center and to exit one of our older, more costly data centers, a move we expect to provide meaningful gross margin expansion as we move into 2015. As a result of this onetime investment, we do expect some lumpiness in our 2014 gross margins on a quarter-by-quarter basis.

We expect to see continued growth in free cash flow during 2014, and for the full year, we expect to deliver free cash flow in the range of $12 million to $14 million before onetime items associated with the relocation of our corporate headquarters in Boston and the data center relocation I mentioned previously.

Overall, we remain optimistic about the opportunity ahead of us and feel that we're very well positioned to be a winner in the SMB business continuity market.

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

Question-and-Answer Session

Operator

[Operator Instructions] And it looks like our first question will come from the line of Bhavan Suri with William Blair.

Bhavan Suri - William Blair & Company L.L.C., Research Division

As you look at the business and you look at the growth in the SMB, could you just give us some sense of what's driving that growth in terms of any verticals or any specific partners or any specific go-to-market strategies?

David Friend

This is David Friend. The product that -- we're not concentrated in any particular vertical. We did announce HIPAA compliance, which I think has given us significantly more traction in the medical market, but the product seems to have cut a very wide slot in the marketplace, with nearly every traditional small- to medium-size business vertical showing considerable interest. Just keep in mind that, throughout last year, essentially the only product we were selling was our traditional endpoint backup, which we know is a secondary concern for many businesses. Most people are worried about their servers first, and that's why we were very anxious to get our server product out in the market. And that was in fact launched on, I think it was, January 8, with the launch of our new website.

Bhavan Suri - William Blair & Company L.L.C., Research Division

Okay. And then when I look at the bookings guidance that you guys just gave, obviously, there's really solid, great growth in the SMB space, offset by the weaker growth in consumer, which sort of means a further deceleration in bookings growth maybe in '14. But as the SMB part becomes bigger, you look out to '15 or '16, just some sense of sort of when we should see that reaccelerate. And is that driven by the fact that SMB will just be larger than consumer at one point? Or does consumer start to sort of stabilize and at least start growing back in the, say, mid to high single digits? How should we think of that not even for '14 but going out a couple of years?

Anthony Folger

Bhavan, this is Anthony here. I think you're right in the fact that we see some deceleration because of the size of the consumer space. And we know that even for the full year in '13, the growth rates came in sort of at that 5% range and there was a little bit of lumpiness there. So we do still think it's a healthy business. We do think we can continue to grow it in sort of a -- sort of low single-digit type range, but I don't see it being high single- or low double-digit grower at this point. And certainly, from a media and customer acquisition perspective, we're not going to invest in an inefficient way in acquiring new subs there. So we think it's controllable, we think it's a segment that we can continue to grow at a modest pace. It will throw off cash flow. And then as the SMB segment sort -- starts to catch up in terms of the scale, I think it will begin to move the needle for the overall company more and more. Certainly as we go into 2015, I think that will be the case.

Bhavan Suri - William Blair & Company L.L.C., Research Division

Yes. So if you look at that growth rate, 30% to 40% growth, and again let's look at it longer term, what do you think the sustainable growth there is? So when I look at '15 or '16, could that business, do you guys view that business to grow, say, 25% to 30% from a bookings perspective?

Anthony Folger

Yes, I mean, it -- for us right now, we just launched our server product as a standalone sale. And we had sold that as an add-on to our endpoint backup earlier in the year. We're starting to see pretty good early results from our standalone server sales, but it's somewhat early to tell. We do have a business continuity appliance that will be launched, that we've got high expectations for. And we're seeing -- I would say, in terms of go-to-market, we're seeing very good results from the reseller channel. So I think our focus is going to be on building out distribution capability, bringing new products to market frankly at a higher average order value. Our goal right now is to get the growth rate on SMB accelerating and get the growth rate overall for the business accelerating. That, to me, still looks out a couple of years in terms of wanting to keep the acceleration going, so we -- it might be a little bit early to talk about steady-state growth on that side of the business just yet.

Operator

And it looks like our next phone question will come from the line of Ben Rose with Battle Road Research.

Ben Z. Rose - Battle Road Research Ltd.

Dave, Anthony, on the SMB side, can you tell us whether -- from a channel perspective whether the channel is now up to 10% of sales; and if so, what your expectations might be as the year unfolds?

Anthony Folger

Yes. Ben, it's Anthony here. I -- we're not really breaking out the direct versus indirect mix just yet. I think it's still a bit early. Our expectation is that, that does contribute in a meaningful way in 2014. And I think, when we -- the reason we'll -- we don't want to give it out is because it's growing at a very fast clip off a small base. When we think it's driving growth in the overall business, I think we will want to talk a bit more about it in terms of the metrics and what it delivers for the business.

Ben Z. Rose - Battle Road Research Ltd.

Okay. And with regard to advertising, I know that, at least historically, the consumer portion of the business has been very sensitive to your radio and TV advertising. Are you still seeing the same? And I guess, really 2 questions here. Are you still seeing the same level of sensitivity to -- in terms of gaining results from the advertising? Or is the consumer business kind of taking on its own course? And then secondly, with regard to advertising and promotion of the small business products, could you speak to how the channel programs from a promotion standpoint might differ from what you've done historically on radio and TV?

Anthony Folger

Sure. I think what we've seen on the consumer side is a decrease in our efficiency at acquiring new subs with a consistent level of media spend. And as a result, we've already started to pull back. And in fact, in Q4, we took some pretty big swings at the media budget and started to pull back then, sort of stacked ranking from most to least efficient in terms of advertising vehicles and going from the bottom and working our way up. It -- that's a process we're going to continue to do. And I think we're being as scientific about it as we possibly can. We're not seeing a negative impact on the business, on the consumer side of the shop at this point. And so I think we'll continue to fine-tune there and get to the right level of spend from a media perspective so that we can still drive the level of growth that we feel comfortable with. And like I said, we still believe consumer is a cash cow for this business and funds a lot of what we want to do on the SMB side. As we think about redeploying dollars to the SMB go-to-market strategy and deploying into programs for our reseller channel, on a dollar-per-dollar basis, I think that the spend is probably a bit less on the marketing side. But I do think that what we see, in particular when we're selling server backup and business continuity appliances, we're bringing on more of an inside telesales presence for the company because we know that selling those products at a higher price point and frankly to a more sophisticated IT environment requires a little bit more touch, not heavy touch, not direct sales or field-based sales but certainly an inside telesales presence. And so I think the trade-off there is going from direct-to-consumer marketing to more of a reseller channel-oriented strategy. And it certainly requires less from a marketing and media perspective through the channel but a little bit more because of the sales component that needs to support those efforts. So I think we'll look at it as just redeploying media to channel for now. And hopefully, we can get some leverage in our model as a result of it, but we'll see how the year progresses.

David Friend

I guess I'd also just add that, if you listen to our ads on the radio or TV, you'll notice that more and more of our ads are actually in support of the small business market, which benefits, we think, both the medium-size business efforts and also the consumer efforts. So we're trying to change the image of the company in -- the perception of the company in the public's mind from being purely a consumer backup company, and so there's a significant change in the emphasis and even in the content of the advertising that we're doing.

Operator

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

Richard H. Davis - Canaccord Genuity, Research Division

You kind of touched on this, but if you could add a little bit more color on how you kind of see the -- your sales organization and/or kind of sales efforts on the SMB side kind of evolving because you're moving a little bit from kind of one model to the next, that would be helpful.

Anthony Folger

Sure. It's Anthony here. Just I think the evolution for us is triggered by bringing new products to market. I think Carbonite is a company who is very successful in marketing direct to consumers, driving people to our website and getting them to convert at $59 for an annual sub. I would say that we were also very successful selling endpoint backup to small businesses and, really, reaching a lot of those small businesses and their channel partners in the same way, with media driving them to our website and converting them. And that was for a $229 product. As we started to move into products like server backup and appliances, we're talking about a $1,000 product or north of $1,000. And we know that the end customer for these solutions is generally going to be a value-added reseller or an IT professional. And I think, fundamentally, we reach those people a little bit differently and we close those deals a little bit differently. And it will require, we think, not an overly large inside sales organization, but we're certainly making investments in inside sales so that we've got smart technical salespeople on the phone that can address questions that these folks might have. And we're, I think, doing a lot more with our reseller channel right now in terms of training, formalizing partner programs, getting the materials they need on our new product sets so that they're able to sell into that more sophisticated environment and to that end user as well. So I think the model will continue to evolve where the marketing efforts are going to start to be more focused on our channel partners and more focused on the IT professional, which tells me that it's probably less TV and radio. And I think it's going to require a little more hand-holding from an inside sales organization, and that will be predominately inside sales, telesales.

Operator

Our next phone question will come from the line of John DiFucci with JPMorgan.

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

Anthony and David, it's -- you're talking a lot about redeploying marketing dollars for media which is mainly targeting consumers to more channel oriented, even in the media, to look more towards the SMB. So you kind of get that, but the -- and it all makes sense, but in the current quarter, the 5% growth of consumer, which -- that's interesting. I mean, that's a pretty low growth rate relative to what we had seen or even expected a year ago. So I guess the question is, is that growth rate because of this change in approach? So is it more marketing driven? And I'm not talking about going forward, I'm talking about right now. Or has this market -- it's been an okay market and you've come to the conclusion, based on even these results, that it's just not the kind of market that you thought it was a year ago, is it -- is that it? Or -- so I guess, is it more marketing driven, or is it more market driven? What's happening right now in consumer?

David Friend

I think it's a little bit of both. First of all, we made the decision to make a big push into the SMB market because, about 2 years ago, when we started this, a little less than that, it didn't take us long to discover that a dollar deployed into the SMB space was producing a higher return on investment than a dollar invested in the consumer space. We had higher profit margins, we had higher average selling point. There was less sales support, the renewal rates were higher. It just seemed like everything about those sales was more favorable to the company. So that's really when we decided to make -- when we made the decision that we would start deploying resources in a serious way toward the SMB space. I think it's also true, and this can be seen in our costs of acquisition, that the decline in PC sales, particularly home -- interest in home PCs and so forth, the proliferation of all kinds of free storage on the web that allows people to store things in their 5-gigabyte-free Gmail accounts and things of this sort, has complicated things a little bit more and made the market a little less attractive. So I think it's a combination of both just interest on the consumer side flattening out a little bit, and also, I think, probably more significantly that Carbonite sees a better opportunity in the SMB space where there's -- pretty nearly every small business is already backing up. In the consumer space, we had to convince people who were not backing up at all that they needed to back up. In the small business space, everybody already is, but they're backing up to hard drives and thumb drives and old-fashioned tape backups and all kinds of systems like this, which we found are actually pretty easy to displace. And so we just -- we see it as a more fertile hunting ground.

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

That all makes sense, David. And Anthony, just sort of quick follow-up. You just talked about free cash flow guidance for next year, and it -- that sounds great, actually. But you also mentioned that -- those excluding some onetime hits due to the relocation of the headquarters and the data center. Can you at least roughly quantify what those hits would be?

Anthony Folger

Well, I don't want to -- it's not something that we're putting out just yet, John, but we'll certainly give people insight as the year goes on, specifically as to what those costs are. And it's really just because of the lead time. The lead time for both projects is fairly long. For example, the corporate headquarters, we don't expect to be relocated until the end of the year. And the cost budgets for these projects will be dynamic as we move through the year, and we'll certainly do our best to be as efficient as we can possibly be. But I think, because of the long lead times on some of these projects, we didn't want to give out too much specifics on the expected costs. Obviously, we've got detailed projects -- project plans and budgets for these, but it's just not something we wanted to put out until we get a little more into the projects and a little more through the lead time and have some results behind us.

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

Okay. But just to get some sense because, I guess -- forget about the lead time for a second because it's the headquarters' move moves into next year, I understand that kind of stuff. But these projects, are they going to eat up half of free cash flow, or all of it? Could it be negative if they -- you did them both? I don't think they would, but...

Anthony Folger

Yes, and then that was [indiscernible]. I -- directionally, I will say we still expect -- even after accounting for these projects, we still expect to see improvement in our free cash flow '13 to '14...

Operator

Our next question in the queue will come from Tim Klasell with Northland Securities.

Tim Klasell - Northland Capital Markets, Research Division

Just a question around sales and marketing and gross margins as we move into more of the SMB market. With all the capital expenditures and what have you, those numbers will be moving around a bit, but the goal to go into the SMB was to improve, I think, both lines, efficiencies on both line. Can you give us sort of an idea of what those numbers would be or what your target mark -- model is for the gross margin and the sales and marketing line as you move into the SMB?

Anthony Folger

Yes. And I think, Tim, that we -- from a long-term perspective in terms of gross margins, as SMB continues to contribute more and more, I think our long-term model is pegged in sort of the high-70% range in terms of gross margin. We did mention that, this year, we may be a bit flat and gross margins may be a bit lumpy quarter-to-quarter because some of the activities that we're doing and the investments that we're making to relocate with our data centers. We're obviously doing that because in doing so, we really think that we can move the needle next year in terms of expansion and start to push over some pretty good thresholds. And I think long-term picture still remains the same. And I think the investments that we make this year, in '14, are going to be very -- set us up very well for '15. On the sales and marketing line, I think we've seen good leverage in that number throughout the year. I think we're being a little bit cautious going into 2014 because we know that we're going to continue to redeploy and we're going to continue to invest in domestic and international channel expansion. We're going to have to be pretty diligent about making sure that we keep consumer on-track and, at the same time, that we redeploy effectively to our reseller channel, which really has been the most productive channel in terms of go-to-market for us as of late. And so we're not predicting a ton of leverage this year in the model, but I think our long-term model would probably show us continuing to get leverage on the sales and marketing line somewhere down to maybe a 35% level.

Tim Klasell - Northland Capital Markets, Research Division

Okay, good, good. And then you obviously have had some great success with distribution and with resellers, but how are you going to handle channel conflict with your own internal sales force at -- your telesales force? Because clearly, there's -- the effort can be a bit of a minefield.

David Friend

Yes, Dave here. Yes, the intent is to -- obviously, when we advertise, the phone rings downstairs and there are people on the phone who want more information or want to just buy. And to the extent possible, we will leverage those by handing them over to channel partners. So our intent is to try to avoid channel conflict by always erring on the side of, "Let's give it to the channel partner," but in return, we want something back from that channel partner, which is we want access to their other customers. Most of these VARs and resellers that we are dealing with, in the past, have come to us because, as you know, it hasn't been very long since we've had a very serious sort of what I'd call an outbound sales effort to VARs and resellers. Most of them have come to us because a customer of theirs had heard one of our ads, went to them and said, "What do you think about this Carbonite stuff?" And the VAR calls us, says, "How do I become a reseller?" Well, that VAR probably has 30 other clients or customers just like that one. And in return for us bringing them into the sale, we want them to bring us into the sale. This is a fairly well-worn what we -- they call in the industry the give-to-get ratio. And so for every one of these that we hand over to a VAR or a reseller, we expect something in return.

Tim Klasell - Northland Capital Markets, Research Division

Okay, good, good. And then one follow-up question. And I know it's fairly early days with the server products and what have you, but if you look at your target market, how -- what's the ratio do you think of endpoint backup to server backup as far as the addressable revenues?

David Friend

Well, IDC put out some research on that, which would tend to indicate that the interest -- in the sort of the lower end of the SMB market, the interest in endpoint backup and server backup is roughly equal, so you would infer from that, that about half of businesses in that sort of lower end of the SMB market would want both endpoint and server backup. But as you move up market, the interest focuses more on the server end because a lot of companies are already doing some kind of replication between the endpoints and their own internal servers. So they focus -- the focus becomes more on the servers. And certainly, from a business continuity standpoint, if an endpoint, if the PC on your desk or your laptop dies, that's not the end of the world for the business, but if a server goes down, pretty much, the business stops until that server is brought back up. And we think that's really where the game is going to be played. If you're asking me what kind of metrics do we want to drive for years out, it's going to be service-level agreements with customers that say, "We're going to get you back up and running faster than anybody else can." And that's kind of, I think, where we'll be driving to in the market.

Operator

And our next phone question will come from the line of Brian Schwartz with Oppenheimer.

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

You talked about the reseller channel being a very effective channel for distributing the products. Can you update us on your expectation of the progression of the reseller channel getting all the products being able to be sold, if that's something that's going to be happening here in 2014, or that's a 2015 target? And then also with the reseller channel, can you talk about your growth expectations? I think you gave us a number of 4,300 ending the year. Where do you think that number is going to go in the end of 2014?

Anthony Folger

Sure. It's Anthony here, Brian. I think we -- I guess, the answer to the second question first, we're sort of a little bit reluctant to guide on the number of resellers. We think we've done a very good job building that channel up to this point. We are starting to fold more distributors into the mix. And really, I think the game for us going forward is going to be continuing to add resellers to the mix but also getting more yields out of each reseller. And to Dave's point earlier, when we talk about channel conflict, I think really the objective for us is to take our inside sales organization and really take a lot of the direct engine and machinery that we've had in the past and aim that at our channel. And in doing so, we hope that we get a better yield from each reseller and continue to sort of slowly and steadily build that channel out. But we're not really going to guide on the number of resellers we're looking for or the number we think we need to be effective because it really is going to be a mix between quantity of resellers and sort of the yield per reseller that we can get.

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

And then the second -- I apologize, it was a long question. Can you update us? I'm just trying to understand how many products the reseller channel is selling today. Are they just selling the endpoint product? Are they selling the full suite of products? And what do you think the progression will be from a time line standpoint of selling the full suite of products from Carbonite?

Anthony Folger

Yes -- sorry about that. Yes, we, right now -- the reseller channel started with the endpoint products. During the year, we added the ability to sell server as an add-on to endpoints, and we did that first for our channels. And then just in January, maybe 2 weeks ago when we rolled out our new website and our new plans, resellers now have the ability to sell server as a standalone product, and resellers are selling all of our packages at this point. So as we continue to launch new products, obviously, the reseller channel is an important one for us. And I think we'll ensure that what we bring to market is ready for that reseller channel when we launch.

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

And one follow-up question. Was just hoping to get a little more color on the international strategy in 2014. You've talked about it a couple of times on the call, but I don't think you've fully flushed out what your plans are, what regions you're looking to go into and what impacts of that strategy will be for growth moving forward.

Anthony Folger

Sure. From an international perspective, we have already begun making some investments there, getting sort of the structure and the organization enabled to hire, to sell, to run the business internationally. We do have products. And our server backup product that was acquired as part of the Zmanda acquisition is localized in multiple languages. So we're evaluating regions right now in Europe and Asia. We're actively talking to our partner network and obviously leveraging some of the same partners that we've got here in the U.S. internationally. And we've got the -- I think, the luxury of having value-added resellers on the go-to-market side. And we've also got folks on the supply chain side for our data centers who act as resellers throughout the world. So we -- by virtue of our business model, we've got a good network of partners to tap into. And we are actively in discussions with partners right now in a couple of different regions. We're not factoring into our expectations a material contribution of bookings contribution from international, but I think the objective is to be up and running internationally this year so that we can start to talk about it when we look at contributions for 2015.

Operator

And our final question will come from the line of Rob Owens with Pacific Crest Securities.

Rob D. Owens - Pacific Crest Securities, Inc., Research Division

Question on the revenue guidance for Q1. Given the subscription-like nature of your business, why would revenue be down sequentially? And have we ever seen this historically? I understand renewal rates flipped to the lower end but still at 96%, and there was a partner there. But just want to get some color around Q1 and how revenue is coming off the balance sheet.

Anthony Folger

Sure. I think the -- there historically has been a bit of seasonality in the business from a bookings perspective, and this goes back to sort of the early consumer days where we were spending heavily on media in Q1 and Q3 and that would drive certain behavior with subscriptions and creates large renewal cohorts that sit in certain quarters. And so the sequential growth for us is maybe a little bit less telling than the year-over-year from a quarterly basis. And we know that overall for the business, in the back half of 2013, we saw the growth rate slowed to the sort of low to mid-teen level, 14% and 15%. And I think that the revenue that we're projecting for '14 and in particular for Q1 is really a reflection of that activity in the second half of 2013 and sort of the guide that we gave on bookings for '14. I think the combination of those two is what got us to the revenue guidance for Q1 and the full year.

Rob D. Owens - Pacific Crest Securities, Inc., Research Division

So I mean, I assume, given the ramp -- unless you're already expecting seasonality in SMB, which given how small it is I wouldn't sense that would be it, so is the ramp in billings or the -- as you guys are kind of tempering your marketing spend and there's not as much consumer growth, is that not offsetting the churn in the business? I'm just not clear why revenue would be down sequentially on what has been decent billings performance and billings growth over the last year, unless there's something mechanical I just don't see.

Anthony Folger

Yes. No, I think, obviously, when we think about the growth in revenue with average terms on our deals running fairly consistent in being just north of 1 year, we're looking at the trailing 3 to 4 quarters of bookings activity and we're using that to project our revenue growth going forward. We're trying to be conservative, where necessary, as we look at the bookings plan for 2014. I think there's always opportunity to achieve a little bit better on the revenue side to the extent that, in '14, we're successful in selling products with a higher average order value and the revenue will get amortized in more quickly and allow for some upside there. But that's not something that we wanted to get too aggressive with as we guided for '14.

Rob D. Owens - Pacific Crest Securities, Inc., Research Division

Okay. And then second, on the sales and marketing front, as you guys pivot and focus more of that investments on channel and channel education and awareness, just a general question: As we look at other brands that have been very successful in SMB, I'm thinking one in particular that advertises in airports and in a lot of media, it appears that driving channel awareness actually helps those, the efforts, quite a bit, especially given the expansive reach of some of those other brands. So just curious, if you're going after the SMB and kind of that smaller end of the SMB, why you wouldn't continue similar efforts around consumers to help drive awareness, and what the potential risk there is.

David Friend

I don't think there's any intention of backing off from the brand-building part of Carbonite. I know the advertising program you're speaking of. We've been admiring it a great deal, in fact. And anecdotally, what we hear from VARs is that selling Carbonite to their customers is far easier because, the fact that most customers have heard of Carbonite, the name is well known, and in fact, that we were able to build a network of over 4,000 active resellers with almost no outbound effort, testifies to the power of the brand awareness and the company's reputation in the marketplace. Now that we're actually starting to do outbound, we're seeing that, that is even more beneficial because when you call somebody and they know your name and they know your presence in the marketplace, you get the kind of attention that you would certainly not get if you were an unknown company with an unknown product and an unknown brand. So we're -- we expect to continue to leverage that. And I'm a big believer in the value of brand, especially in the SMB market.

Anthony Folger

Yes. And I think just a follow-up to that is that on the consumer space for us, media was a means of acquiring new customers and it was really the only means of acquiring new customers. To Dave's point, we're going to still continue to build the brand. We know it's important for the business. But in terms of acquiring new subs, I think that's where we're going to see the shift in sort of the resource allocation from media to some other channels.

Operator

And with that, that does conclude our time for question. I'd like to turn the program back over to Mr. David Friend for any additional or closing remarks.

David Friend

Thank you, operator. And I want to thank everybody for joining us today, and we look forward to speaking you again next quarter.

Operator

Thank you, sir, and thank you presenters. And thank you, ladies and gentlemen. This does conclude today's call. Thank you for your participation, and have a wonderful day. Attendees, you may log off at this time.

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