Interactive Intelligence's (ININ) CEO Don Brown on Q4 2015 Results - Earnings Call Transcript

Interactive Intelligence, Inc. (NASDAQ:ININ)

Q4 2015 Earnings Conference Call

February 1, 2016 04:30 PM ET

Executives

Don Brown - Chairman, President and CEO

Ashley Vukovits - CFO

Bill Gildea - COO

Analysts

James Faucette - Morgan Stanley

Dan Bergstrom - RBC Capital Markets

Mike Latimore - Northland Capital Markets

Dmitry Netis - William Blair

Richard Baldry - ROTH Capital Partners

Jonathan Kees - RW Hambridge Summit Research

Jeff Van Rhee - Craig-Hallum Capital Group

Operator

Good day ladies and gentlemen, and welcome to the Interactive Intelligence Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded.

I’d now like to introduce your host for today's conference Miss Ashley Vukovits. Ma’am, you may begin.

Ashley Vukovits

Thank you. Good afternoon and thank you for joining us today to review Interactive Intelligence’s fourth quarter and fiscal year 2015 financial results.

With me on the call today is Don Brown, our Chairman of the Board, President and CEO; and Bill Gildea, our COO. Don will begin with an update on our key initiatives. I’ll then review our fourth quarter and fiscal year financial results in more detail and provide the financial outlook before turning it back over to Don for closing remarks. 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 makes 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 2014 Form 10-K and our other public filings with the SEC which describes 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 non-cash stock-based compensation expense, purchase accounting-related adjustments, certain acquisition-related expenses, the amortization of certain intangible assets related to acquisitions by the Company, non-cash expense related to establishing the valuation allowance for our deferred tax assets, and the amortization of debt, discount, and issuance costs 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.

Don Brown

Thanks, Ashley, and thanks to everybody for joining us on the call today. This is an historic call for us for a couple of reasons. For one, it was our first time to ever break the mark of $100 million of revenue in a quarter. I’m very proud to reach this milestone. It’s one that I never could have imagined attaining when I started the Company 21 years ago. We’ve come out of nowhere to take on giants like Cisco, Avaya, and Nortel. It’s impressive to reflect on what we’ve accomplished.

Ashley will cover our fourth quarter results in detail. Overall, it was an excellent quarter, highlighted by our ability to beat our earlier guidance on both the top and bottom lines, with most of this performance driven by increased contributions from the cloud. This call, however, is even more significant because it marks a new chapter for us as a business.

I’m delighted to announce that as of January 1, 2016, we made PureCloud, our primary offering in the customer engagement market. As you know, we’ve made significant investments to develop this entirely new cloud platform. We weren’t content with being a niche player in the communications market and decided to take an audacious step. We gave our architects and designers the green light to start over from scratch and build the most advanced set of cloud based communication services on the market. That effort culminated in the release of PureCloud Engage in the middle of last year.

Rather than taking the traditional approach of building a monolith of interlocking software components and trying to make them work for multiple tenants, we employed a modern microservice architecture, more akin to Facebook or LinkedIn.

PureCloud consists of close to 100 micro services, each stateless and independently load-balanced using Amazon Web Services. This means that PureCloud has no single point of failure, is infinitely scalable, and could add new features on the fly.

If you hear of a software company that can run its service in a private data center or in different public clouds, it’s a strong clue that they’re employing the old monolithic architecture and using the cloud simply as a hosting platform, exactly what we elected not to do with PureCloud.

During the third and fourth quarters, we rolled out the initial PureCloud services like nervous parent sending their child off to kindergarten. We finished 2015 with two dozen customers, and I’m happy to report that our youngster is now a strapping adolescent and ready to take the lead for Interactive Intelligence.

The initial PureCloud deals we closed in Q4, included our first million dollar deal, as well as a sale to a subsidiary of a large publicly traded software company. Two notable aspects of these initial PureCloud deals were how short the sales cycles were and how quickly we were able to deploy them.

In many cases, we had PureCloud deals closed within 30 days from the initial contacts and then deployed within weeks of signing. Overall, we saw enough in Q4 to provide us confidence that the momentum with PureCloud will continue during 2016 and beyond. So here are just a few of the steps we’ve already taken.

First, we created a subscription plan that enables customers to pay monthly for what they use with no commitment and no hidden fees. Two, we price PureCloud very competitively to materially disrupt the market, even as it includes more features and functionality than any of our major competitors. Three, we implemented an online ordering process that allows organizations to purchase directly from our Web site and to change their subscriptions at any time. Four, we created inside sales teams globally to focus on smaller opportunities and revamped our sales commissions plans to encourage sales of PureCloud. Five, we increased our partner incentives and signed up new PureCloud partners around the globe, and six we invested heavily in PureCloud lead generation.

And on the product side, it’s full steam ahead. We were updating PureCloud weekly, enrolling out a steady stream of new features. Last year, we introduced three seat types for PureCloud; Collaborate, Communicate, and Engage at price points of $10, $20, and $100 respectively. We now have added two new Engage seats, a less expensive one at $70 for simple call center operations and a more expensive one at $130 that includes advanced contact center functionality.

It’s important for our investors to understand that we’re attacking the entire range of the customer engagement market with PureCloud. We believe we can effectively meet the needs of organizations that have five contact center agents or 50,000. In our weekly load testing, we’re now handling loads of 400 calls per second, which is equivalent to 400,000 contact center agents in each of our three regions. And since we are adding a fourth region this month, this gives us a current capacity for 1.6 million concurrent agents, which is way more than we’ve sold in the history of the Company.

PureCloud more than doubles our addressable market compared to our previous product offerings. Beyond scalability, PureCloud continues to evolve functionally at a very impressive rate. The initial PureCloud service already have rich capabilities including speech enabled IVR; skills based routing of phone calls and Web chats, outbound predictive dialing, and stereo call recording.

However, over the course of the next few weeks, we will be rolling out a long line of new features including group ring, outbound fax, agent scheduling, email routing, response management, screen recording, speech analytics, social media routing and many others. And it’s important to understand that these are all using technology that we built ourselves compared to our competitors who have to pay hefty license fees to companies like Nuance for Speech recognition and Verint for quality monitoring.

I’m also pleased to announce that we’ve developed our own Web co-browsing technology that will allow organizations to easily offer leading edge service to their online customers. I would go so far as to say that by the end of Q1, PureCloud will be functionally richer than our highly regarded CIC product in almost every way imaginable.

And I’m especially excited to announce yet another strategic new capability for PureCloud that I haven’t talked about before. Just this week we deployed our first customer using our new PureCloud voice services. PureCloud voice is our own setup telco offerings that allow customers to order and provision toll free numbers, DID and other telco services directly from us.

We’ve had a team working in stealth mode to develop these services that allow us to offer everything an organization needs to spin up a call center or next generation contact center. PureCloud voice will also generate additional revenues for us and with the sorts of volumes we already have allow us to earn very nice margins on these revenues, while being able to deploy new customers in a matter of hours.

Overall, we feel that we’ve greatly enhanced our already enviable competitive position with PureCloud. We built our own technology for speech recognition, quality monitoring, workforce management, Web co-browsing, video collaboration, social media monitoring, and telco services.

We can -- we believe we can package all of these functionality at price points that our competitors can’t touch, deploy it in timeframes that can’t match and yet do so at 70 to 80 point margins that will make us nicely profitable in the years ahead. We are retooling our sales force for speed and volume. We will continue to sell our world-class CIC product and single-tenant CaaS solution for customers preferring those types of deployments, but PureCloud will now be our primary offering in the customer engagement market.

The early results for PureCloud are quite encouraging. Our initial win rate was close to two-thirds and a number of those wins came against Five9 and inContact, although PureCloud also took business from Cisco and Genesis. We didn’t rollout PureCloud to our entire sales force until January, but have already seen a quadrupling of the number of active PureCloud sales opportunities and now have several hundred in the pipeline.

We’ve live PureCloud customers in the U.S., APAC, and EMEA. One is among the world’s largest online mortgage company, an opportunity that went from contract signature to go live in 40 days. This was a complex deployment with international contact centers and remote agents using PureCloud voice. Such initial data points make us very excited about the prospects for PureCloud growth in 2016. With this strategic overview as a backdrop let me turn it over to Ashley, to dive into the numbers.

Ashley Vukovits

Thanks Don. As Don mentioned, our fourth quarter results were above the high ends of our guidance. Total revenues were $107.7 million, up 16% year-over-year with non-GAAP earnings per share of $0.12. We also produced $13 million in cash flow from operations in Q4.

Two factors primarily drove the upside in the quarter. First of all, customers embracing the cloud more quickly than expected, as cloud revenues grew 53% during the quarter. And second, a laser like focus on reducing our overall expense base as we transition to a leaner more efficient cloud company.

Before I get into more specifics on the quarter, I think it’s also important to recap our full-year results. Many software companies have made the transition from premise to cloud. As investors know, it takes time and the road can be bumpy. For the fiscal year 2015, we grew the top line 15%, delivered positive non-GAAP operating income, produced $25.6 million of cash flow from operations, started the gain traction again in our growth margins as we focus on operational efficiencies and probably most importantly from our standpoint, we grew our cloud revenue 62% for the full-year to nearly $100 million.

Now to dive into the quarter. Our recurring revenues which includes both maintenance contracts and cloud based revenues were $63.4 million for the quarter, representing 59% of total revenue up from 55% in the year-ago quarter. This growth continues to be boosted by the rapid growth of our cloud based revenues, which were $29 million for the fourth quarter, a year-over-year increase of 53%.

We also saw a 6% increase in premises maintenance revenues, resulting from the increasing install base of premises based customers. In addition, services revenues totaled $16.6 million, up 16% compared to the same period last year and license and hardware revenues were $27.7 million, up slightly from $27 million in 2014.

Non-GAAP gross margins were 62.6% in the fourth quarter, up from 61.8% during the same quarter last year and up from 61.1% in Q3 2015. Non-GAAP services revenues gross margin was 38.8% compared to 25.7% last year, which increased significantly due to our ability to utilize a lower cost workforce outside of the U.S for certain services function.

Total non-GAAP operating expenses were $63 million, up 4% sequentially and demonstrating leverage on a 11% sequential revenue growth. We continue to reduce our total capitalization of PureCloud development costs as the majority of the plan features that of Engage, Communicate, and Collaborate is now GA.

For Q4, we capitalized $900,000 of development cost compared to $6.6 million in the fourth quarter of 2014. As a reminder, we began the amortization of previously capitalized research and development costs last quarter, which added $1.8 million of expense to cost of cloud revenues during the fourth quarter and reducing our recurring gross margins by approximately 300 basis points.

Total headcount ending 2015 was 2,309. Importantly, excluding contingent employees, headcount increased only 9% for the full-year, reflecting our move to outsource certain services and development work to lower cost regions of the world. These trends will continue into 2016 and 2017, as we strive to capture more operational efficiencies and further our efforts at automating our business.

Non-GAAP operating income which excludes stock-based compensation expense and purchase accounting adjustments with $4.5 million in the fourth quarter of 2015, significantly better than our guidance range of $1.8 million to $2.6 million, primarily due to ongoing implementation efficiencies and lower operating expenses.

Non-GAAP net income for the fourth quarter was $2.6 million or $0.12 per share based on $21.7 million fully diluted shares outstanding. This compared to non-GAAP net income of $5.5 million or $0.26 per share based on $21 million fully diluted shares outstanding in the fourth quarter of 2014. During the fourth quarter, GAAP operating loss was $700,000 and GAAP net loss was $3.5 million or a loss of 16% -- $0.16 per diluted share.

Turning again to the financial results for the 2015 fiscal year, total revenues were $390.9 million, up 15% compared to 2014. Recurring revenues which includes both maintenance contracts and cloud based subscription were $230.7 million, up 23% compared to last year and represented 59% of total revenue compared to 55% in 2014. This increase was primarily driven by the growth of our cloud subscription revenues, which were $97.9 million in 2015, a year-over-year increase of 62%.

For the full-year, product revenues were $99 million, which was consistent with 2014. Services revenues totaled $61.2 million, an increase of 12% year-over-year. During the 2015 fiscal year, we capitalized $11.3 million of development costs resulting from our investment in the PureCloud platform compared to $15.2 million in 2014. We amortized $3.9 million of this capitalized software in 2015 compared with no PureCloud amortization in the prior fiscal year.

Non-GAAP gross margin for the full-year was 61.5% and non-GAAP operating income was $3.3 million compared to a non-GAAP gross margin of 60.8% and a $1.5 million operating loss in 2014.

Before turning to the balance sheet, I want to point out that we will no longer provide our traditional cloud or premise order results. Increasingly our growth from existing CaaS customers comes from increased usage which was -- which does not require an add-on order. For PureCloud we have a simple month-to-month consumption based model. Again, we’ve done this to simplify the sales process and eliminate any perceived risk to the buyer.

Our goal is to disrupt the traditional customer engagement procurement process and the early feedback has been positive. Both of these facts create a relationship of orders to revenue that has become increasingly disconnected and therefore we no longer use these metrics to evaluate and operate our business. Instead we will focus on cloud subscription revenues and total revenues for which we will continue to provide future guidance and the number of licensed PureCloud implementations. We have 24 entering 2016 fiscal year and this number will be updated each quarter. We may provide additional PureCloud specific metrics in the future as we learn more about how best to measure the performance of this very new part of our business.

Turning to the balance sheet, as of December 31, 2015 we had $189.5 million of cash and investments compared to $179.7 million as of September 30, 2015. This increase in cash was primarily due to the generation of cash from our operations, partially offset by capital expenditures.

During Q4, the Company generated $13 million in cash flow from operations, used $3.1 million for capital expenditures and adding back $1.4 million in capitalized research and development resulting in free cash flow of $8.5 million.

Accounts receivable days build outstanding as of December 31, 2015, were 89 days compared to 85 days last year and at the end of the third quarter of 2015. Adjusted DSO which takes into account the increase in deferred revenues were 77 days.

Total deferred revenues as of December 31, 2015 were $135.4 million up $14.2 million or 12% from the third quarter of 2015. The increase was primarily due to an increase in deferred cloud revenues related to cash received upfront on annual contracts which will be recognized in future periods.

Let me finish with some comments regarding the Company’s financial outlook starting with our 2016 financial year -- I’m sorry, fiscal year. We entered the year with strong momentum for our PureCloud services and believe that we’re in a position to grow market share as we continue to rollout PureCloud and expand our sales and marketing efforts worldwide. As a result, we’re reiterating the outlook for the full-year 2016 we shared on last quarter’s call. Specifically, we continue to expect total revenues to be in the range of $440 million, which includes cloud subscription revenues of $142 million to $148 million, the midpoint of this range is consistent with the guidance we provided on the Q3 call and doesn’t include any benefit from any incremental customer usage above currently committed minimum.

In addition, we expect non-GAAP operating income in the range of breakeven to slightly above, resulting in a non-GAAP earnings per share loss of $0.79. This is based on $21.8 million fully diluted shares outstanding and a projected long-term effective income tax rate of 40%. Furthermore, we expect to be cash flow -- free cash flow positive which includes estimated CapEx of $15 million.

In the first quarter, we expect total revenues to range between $101 million and $102 million with a non-GAAP operating loss of approximately $3 million to $4 million and a non-GAAP net loss of $0.11 to $0.13. We do expect operating and free cash flow to be positive in the first quarter, which includes estimated CapEx of $5 million.

Our financial goals are very clear. First and foremost, we plan to grow cloud subscription revenues led by PureCloud from the leads we bring in to the sales and partner incentives we offer, all the way through the business to our delivery and back-end processes.

Our second focus is on generating cash. Although we completed the $150 million convertible debt offering in May of 2015, we still believe we need to generate cash to grow -- to show the growing strength of our business. We will do this by continuing to build our base of recurring payments, having customers that will pay annually to receive discount and through our on-premises sales.

Finally, we will focus on further developing operating efficiencies throughout the business to create more leverage on the bottom line. Although this is our third financial goal, it is one that we will put a lot of effort towards in 2016.

It is important to think about the priority order of these goals, because they can have an impact on our short-term financial performance. Clearly, we’re first -- we’re focused first and foremost on growing our cloud subscription revenues, given the rollout of PureCloud, as well as new incentives for the sales team and increased investment in lead generation.

Our visibility into this business is very high and as a result any potential variation to our fiscal year total revenue and profitability guidance, we will be associated with our premise business similar to past years. We expect our premises revenues to decline in 2016, but the rate of this decline will depend on customer purchase decisions and is different from our expectations these decisions can materially affect positively or negatively our top and bottom line guidance.

And now let me turn the call back over to Don for closing comments.

Don Brown

Well, I do want to reiterate Ashley’s last point regarding the guidance on the mix between cloud and premise software, we certainly will continue to provide our market leading flagship CIC product for those customers still seeking a premises based solution and our single-tenant CaaS solution mostly for a higher end private cloud opportunities. But make no mistake; we are entering 2016 with an all-in mentality to drive PureCloud sales on a worldwide basis.

We believe, we have a unique offering in PureCloud which will allow us to crush the competition, while continuing to amass high growth recurring revenue. Accordingly, to the extent new CIC sales taper off more quickly than expected in favor of more PureCloud sales, we make no excuses and believe the faster we can fully transition our model to our multi tenant cloud platform, the quicker our investors will be rewarded for their patience.

I also want to reiterate how we’re well positioned for the future. With two dozen PureCloud deals under our belt and a technology like none other in the industry, I believe we see an inflection point for the entire customer engagement space from SMB to large enterprise and across all verticals where cloud adoption is here.

We aim to disrupt the customer engagement marketplace by one, making the traditional procurement and contracting process and afterthought, two, providing low-cost quick installation packages to get customers running live traffic and three, continuing to add additional PureCloud features at a rapid pace.

As a result, customers can easily consume PureCloud services, expand usage and to add additional services at their own pace. The feedback we’ve received from prospects, small and large, centers around the rich UI and collection of all in one features, the speed of getting up and live and the ease of administration and self-help support. Again, PureCloud is a game changer for our industry and we’re excited for 2016 and beyond. We are ready to drive this opportunity home and dominate our industry.

And with that, we will turn the call over to the operator for the Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from James Fawcett from Morgan Stanley. Your line is open.

James Faucette

Great. Thank you very much. I just wanted to ask a couple of questions as it relates to your legacy customers and your -- in your sales chain. First, on the legacy customers, what’s your sense as to what their appetite for PureCloud might be? And at what point do you think that we could start to see them as a group or at least individually start to transition over to PureCloud and what would be the impact on an -- on how we should think about the financials? Because obviously there will be some service -- ongoing service revenue that will shift to PureCloud. Then my second question just has to do with the channel, and from your perspective does the growth in PureCloud, is that going to create potential channel conflict or issues around that or and how do you plan to address that potential? Thank you very much.

Don Brown

Sure. Well, first of all, from a very simple financial standpoint, thinking about existing customers, the way I look at it is this. In terms of maintenance that we’re getting from existing customers, that is a fraction of the cloud revenue that we get on a per agent basis. If we say the average C-price for Engage is $100 per agent per month, we’re getting a very small fraction of that from customers today in terms of maintenance on premises based products. So there is a huge opportunity in my estimation in moving those customers, keeping those customers, and helping them transition to the cloud. We think that there is a pretty big financial upside. One of the 24 customers we had last year was an existing customer, and we’re now going to a number of our existing CIC and CaaS customers, and we’re in the process of negotiating with several of them to move to PureCloud. I think that effort will pick up steam over the course of the year and certainly will be a major theme at our interactions event, our global customer event in June. And there, we will actually be unveiling some new features that will come out in a -- our new release of CIC that hits in May that builds in a bridge to PureCloud, that synchronizes agent information between CIC and PureCloud, because we not only want to allow -- encourage existing CIC customers to move to PureCloud, but until they’re ready to make that leap, we’d like to be able to sell them cloud services from PureCloud that operate in conjunction with their existing CIC product. So, now hopefully that answers your question. We are certainly not ignoring that customer base. We think it’s a tremendous asset. A lot of those customers are thinking about the cloud. They’re of course hearing a lot about PureCloud and asking for briefings. So even some of our largest existing CIC customers are asking us to come and present on PureCloud. In terms of our channel, we -- this is kind of our second go round with the cloud, we have been selling CaaS now for several years. I would characterize the adoption by the channel as somewhat tepid. That change in business model was pretty abrupt for partners and a lot of them were skeptical about exactly where the world was going. I think this time around, there is much less skepticism. It’s pretty obvious that a huge part of the market is moving to the cloud. We’ve also increased incentives for our partners and are trying to make it as attractive as we can. We can’t change the underlying business model. It is a subscription model, but we have had more adoption on the part of our partners, we’re talking to additional partners around the world. So we’re optimistic about what we can do with the channel, but at the same time we’re not waiting just as we didn’t wait with CaaS. So customers can go directly to our Web site and sign up. We can fulfill those orders directly. We’ve a direct sales force out there that is moving aggressively to market PureCloud. So it will be -- a continued combination effort of our direct sales organization, but hopefully with a growing participation on the part of a growing channel.

James Faucette

Great. Thank you.

Operator

Our next question comes from Dan Bergstrom from RBC Capital Markets. Your line is open.

Dan Bergstrom

Yes, thanks for taking my questions. I know I will get this in the 10-K, but any sense of what on-build future cloud subscription revenue looked like to close the year?

Ashley Vukovits

No, I think we -- I mean it’s steady. Its growing slightly, but not significantly and we will get away from disclosing that. I think we do have to disclose it in the K, but it will be declining in the future as we go away from longer term contracts.

Dan Bergstrom

Any comments on the increased marketing spend, lead generation activities in the fourth quarter? Is that getting you in front of more opportunities and then you’re going to continue that through 2016, correct?

Don Brown

Yes. Yes, I mean, we’re not going crazy or anything, but we think we’ve got a nice opportunity with PureCloud. So we’re incrementally focusing on lead generation. We’ve generated enough leads to create a very nice pipeline, as we said, several hundred PureCloud deals that are currently in it, and we’re looking at continuing to try to step that pipeline as much as we can while being prudent with our marketing spend.

Dan Bergstrom

Great. Thanks.

Operator

Our next question comes from Mike Latimore from Northland Capital Markets. Your line is open.

Mike Latimore

Great. Nice fourth quarter there. In terms of the current cloud gross margin, can you kind of give us what cloud gross margin is today and how does that play out this year as you can implement more efficiencies for CaaS would then bring more PureCloud into the fold?

Ashley Vukovits

Sure, Mike. So, we’re excited to hit just about 50% on our CaaS margins at the end of Q4 and we think those will rise to the mid 50 range even through -- half way through the year, next year or so definitely able to get some operational efficiencies in there that are moving those margins in the right direction. And certainly probably be later in 2016, early ’17 before PureCloud gross margins hit meaningful level, but overall the recurring should increase slightly next year, we’ve the full-year of amortization of the capitalized software so that does run through those recurring margins. But we should see some improvements next year in that as well.

Mike Latimore

Okay, great. And then as you look at your cloud guidance for this year, how much of that is kind of in backlog now versus amounts you have to book throughout the years, let’s say.

Ashley Vukovits

Yes, so a lot of it is already in the door. In fact, the amount of PureCloud that runs to revenue in 2016 is not all that significant and I think we looked at it. We’ve over 92% of next year’s recurring cloud revenues that are already contracted in the pipeline or already implemented.

Mike Latimore

Great. And then, Don, I think you said at the end of the first quarter the features that for PureCloud will be, you said more rich than CaaS. Will that -- does that include sort of the scalability as well as you can put your multi thousand seat customers on this now too?

Don Brown

That’s today. The scalability numbers I gave are today. So we’re not waiting on anything. We run massive scalability test each week and we’re already hitting those numbers that I gave, the 400 calls per second per environment. So we’re not waiting on anything for scalability. I mentioned that we’re rolling out another region, which is actually Japan and that will happen later this month, so that will give us a fourth region out of which we’re operating and just a point to emphasize about PureCloud is that we don’t have to wait for major new releases, so its not like we’re waiting for April 15 for a new release to hit. We are rolling out features week-by-week. And in fact at an earlier meeting today, I learned that email routing is now in-production over the course of this quarter within the next few week we will have some of the others that I mentioned like work force management, agent scheduling and a lots of others.

Mike Latimore

Okay. So what’s the largest customer that you landed to date for PureCloud in terms of just number of seats? I think you said there was a $1 million one?

Don Brown

Yes. We have -- we got customers buying different types of seats Collaborate, Communicate, and Engage. So certainly in the thousands, I guess, I will say in terms of number of seats.

Mike Latimore

Okay. Thanks.

Operator

Our next question comes from Dmitry Netis from William Blair. Your line is open.

Dmitry Netis

Okay. Thank you. Hey, Don, and Ashley.

Ashley Vukovits

Hello.

Dmitry Netis

Question on the Q1, I was hoping you can walk me through your guidance there as it relates to product licenses and cloud revenue, I guess, or recurring revenue. And now that you kind of took away the bookings sort of numbers really difficult to, I guess, get a sense of how things are tracking in each of those categories. So I guess more color would really help to get a sense of which of these -- where these product lines will end up in Q1?

Ashley Vukovits

Sure. So we guided to total revenues of $101 million to $102 million and recurring cloud revenues of $29 million to $31 million. And we also said we expect premises revenues to be down, but as you know the amount that those are down can vary. So we have them down in our model. We’ve services revenues fairly flat given the product revenues, but those are the main components that you will hear us talking about going forward and really where we need to focus is the revenues because of the CaaS usage over and above our minimums and because of the month-to-month PureCloud contracts as well.

Dmitry Netis

Okay. And then, also kind of as I look at your cloud guidance for the year, and I think you’ve answered the prior question saying you’ve got 92% of that recurring revenue already on the books, and I assuming most of it is cash since that’s what drive growth in 2016. So couple of questions, why -- with that level of visibility, why are you guiding sort of lower than your prior sort of guidance, I guess it was in the 50s, 50% to 55%, its now shaking out at about 48% growth? So just kind of trying to ascertain the level of conservatism or maybe there’s something else in the back half of the year that’s going on. So if you could answer that, and maybe also where do you think PureCloud will end up at the end of this year? Is it fair to assume or expect that revenue to be in a 5-ish to 10-ish percent range, higher, lower, I mean anything you’d provide to that would be helpful.

Ashley Vukovits

So, on the growth of the cloud recurring revenues, in Q3 we guided to the 50% to 55%, and in absolute dollars that’s where we’re getting you back to. So we beat our guidance in Q4 and we’re just guiding to the absolute dollars of what we estimated in Q3. So I think you’ll see that, from an absolute value those are same numbers. PureCloud revenues, I think you mentioned 5% to 10%, I mean, I think that’s reasonable. We don’t expect PureCloud revenues to be a significant portion of our revenues in 2016.

Dmitry Netis

Okay. Thank you, Ashley. But weren’t the guidance and I apologize if I’m getting this incorrectly. But weren’t the guidance for 2016 as far as cloud growth was 50% to 55% and not just kind of Q4?

Ashley Vukovits

Right. It was for the full year. But if you add our Q4 actual performance, we came in higher than what we guided. So I think if you use our estimates for Q4 and go back to 50% to 55% to get the absolute numbers, then you’ll get back to that percentage growth.

Dmitry Netis

Okay. For ’16, I got you. Okay. All right, thanks. And maybe the last one to conclude is, on the -- so I guess the question was asked about the scalability of the product. I’m just curious, does that mean Don, you are out there selling PureCloud Engage to both -- to SMB mid-market and large enterprise customers? If I recall, you had the plan to get the scale to large enterprise in the ‘17 timeframe. So does that mean you pulled that in by I guess almost a year now?

Don Brown

Yes, absolutely. In fact we’re quoting on a deal right now with 30,000 contact center agents.

Dmitry Netis

Excellent. Thank you.

Operator

Our next question comes from Richard Baldry from ROTH Capital Partners. Your line is open.

Richard Baldry

Thanks. In terms of the services line, revs climbed sequentially about $1 million and cogs actually went down about $1 million to really give a standout gross margin performance really broke out from anything I’ve seen in the past. Could you talk a bit about how sustainable that maybe? You talked to some of us, I guess an impact of offshore, because this a new level we should think about or there’s some onetime events that need to be, we should think about something more in between the -- where we were and where we’ve gone to?

Ashley Vukovits

Yes, I think our strategy is definitely looking to offshore for some of the services. However there were a few onetime events. So, I think that -- we can think about it in the mid 20s to 30 range for gross margins going forward.

Richard Baldry

And you indicated you sort of changed your sales incentives to push the PureCloud side. So, do you think that has an incremental dampener on the premises revenue that we might have otherwise expected in ’16? And maybe also the same thing you know now it looks like you’re ahead of moving into the enterprise side with it. Could that also be sort of an incremental damper on that premise, right because we might otherwise have expected but with an offset benefit to the higher recurring maybe once those deals close? Thanks.

Don Brown

Yes, and that’s why we’ve tried to give the warning that we did, that we could end up with kind of this perverse situation where we do phenomenally well and sell PureCloud into very, very large deals, but end up hurting our GAAP financials, now just said that the reported revenue and earnings on the income statement. So at this point, we have quite a few premises based deals already pretty well in motion for the first half of the year. So we don’t expect there to be a major impact the first half. But as we get into the back half of the year, it is entirely possible that some large deals that might have gone -- the CIC route will now go the PureCloud route partly because of sales incentives, partly just because of the technical viability of that option. So we just want to be forthright about that, but again in our view that’s a positive thing. If we’re selling PureCloud into very large contact centers and enterprises in place of CIC, we think that’s a great sign.

Richard Baldry

Thanks. The last would be, as you focus more on PureCloud in these monthly contracts and again just moving up into enterprise faster than you thought. Could deferred revenue growth can virtually, completely disconnect from the growth rate of the company itself. People tend to look at that number awfully closely on software companies. So sort of curious if you could tell us in advance that, that could move very contract to maybe your own execution in a good growth scenario so that we’re sort of aware of that ahead of time? Thanks.

Ashley Vukovits

Yes, you’re right, Rich. I mean, we saw deferred revenues grow significantly this quarter, do in part one to annual contracts being paid upfront, but also the unbundled maintenance from premise deals. And both of those things, as we move to the month-to-month usage contracts with PureCloud, there won't be deferred recurring revenues associated with that. And as our CIC sales decline over time, there won't be deferred recurring revenues with that as well. So absolutely you won't see those deferred revenues grow with our growth rate especially as it relates to the cloud business.

Richard Baldry

Right. Thanks a lot.

Operator

[Operator Instructions] Our next question comes from Jonathan Kees from RW Hambridge Summit Research. Your line is open.

Jonathan Kees

Hi. Thanks for taking my question and congratulations on the quarter. If I can ask couple of housekeeping questions to begin with that would be great. I just wanted to see if I can get the new logos for the quarter as well as the -- and my apologies if I missed this, the annual revenue -- contractual annual revenue recurring for cloud contracts?

Ashley Vukovits

Sure. So as far as new logos go, we had just over a 100 in the quarter, and I believe that was up from about 96% a year ago. And then I’m sorry, what was the second part of your question?

Jonathan Kees

The contractual annual recurring revenue for cloud contracts?

Ashley Vukovits

Yes, so we’re not disclosing that. So we’re focusing on the actual revenues in the P&L, but not trying to get into disclosing the ACV of cloud, just due to the fact that a lot of our cloud orders or cloud usage above the minimums, that happens as the nature of the contracts and we don’t require add-on orders for those. And then with PureCloud, those are month-to-month usage contracts for the most part and so we don’t have any annual contracted amounts with those. So that’s why we’re focusing on giving guidance on not only total revenues, but also the cloud recurring revenues.

Jonathan Kees

Okay, got you. Can you at least give the break out between new cloud customers and new prem customers for the logos?

Ashley Vukovits

Yes. So we had approximately 60 new prem logos for the first quarter -- sorry, for the fourth quarter, and that’s pretty similar to the year ago, I think we had 56.

Jonathan Kees

56 for the new cloud. Okay.

Ashley Vukovits

Yes.

Jonathan Kees

All right. Okay, great. Wasn’t that long ago, I guess, in June quarter, I’m moving on from the housekeeping questions here, where premise did a lot better than expected. The overall guidance for 2015 would slowdown, but it was a surprise there and it seemed promising that especially for larger customers that they were still interested in making a security meeting, a control of their equipment and having that on premise. Are you noticing a fundamental shift in terms of the customer mindset? I mean, you mentioned that CIC customers are actually contacting you for presentations by PureCloud. I take it that those are inbound calls. You haven’t even wrapped up your outbound calls, your marketing efforts for your CIC customers. Are you -- why noticing a shift in terms of how your CIC customers, your larger customers are thinking in the recession of cloud? And two, is it fair to say that most of the activity that you’re doing so far are more inbound versus outbound?

Don Brown

Well, the inbound, outbound I couldn’t give you any sort of breakdown, and we talk to our customers, a lots going to have an open dialogue. But clearly there’s an overall move to the cloud that, that trend certainly seems to continue to pick up steam, and I think what's really new with PureCloud is that, well its not even just our existing CIC customers, but even other large organizations now view PureCloud as a viable option. And so, we’ll see how quickly we’re able to monetize that, but it certainly is leading to a lot of interest both from new and existing customers in the cloud. But certainly part of that is just the industry backdrop that more and more companies are looking to move big parts of their infrastructure to the cloud.

Jonathan Kees

Okay, great. And, I guess, my last question is, you’re talking about retooling the sales team. You’ve kind of redesigned PureCloud having more micro skin more of a Facebook and LinkedIn kind of a feel to it. You’re doing all these initiatives and kind of changing things from ground up. I assume this is stuff that is going to be over in the next of quarters not just over this last quarter. Is this stuff which is going to be ongoing or has it -- is it something which is very short in terms of these revamping and changing of your sales team and the products?

Don Brown

No, I guess, I would view it as long-term in terms of, this is -- we fundamentally changed our business. It’s a fairly, a major transition that we’ve gone through. It’s something that we’ll continue for a long, long time. We’ll be fine tuning this. It’s not something that we can execute in a quarter and then we’re done. I’ll just say, we’ve certainly made tremendous progress, and as a company I think everybody from product development to marketing to sales, services; every area understands that our future is the cloud.

Jonathan Kees

Okay, great. Good luck there. Thanks again for taking my questions.

Don Brown

Thank you.

Operator

Our next question comes from Jeff Van Rhee from Craig-Hallum. Your line is open.

Jeff Van Rhee

Great. Thank you. Couple of questions. I guess, Don as you look at PureCloud out of the gate at 2000 customers, I guess a couple of questions there. Can you breakdown of the customers you’ve landed already, where are they coming? Just a sense of what’s Communicate, Collaborate, Engage, and maybe a little more color on how many were new, what were cross sells, sort of the average customer? And then if you could contrast that, because it sounds like the pipe is accelerating considerably. What that new -- that go forward pipe looks like again in those same sorts of strata if you will. What are new versus cross sell to existing seat count, customer size, just a little of contract of those two will be helpful?

Don Brown

Yes, I mean just -- I’m not going to do a lot of slicing and dicing on 2000 customers, but just kind of globally in terms of those customers, and probably more importantly the prospects in our pipeline they’re overwhelmingly new. So, these are mostly new organizations. We’ve just started to have those conversations with our existing customers, existing CaaS or CIC customers. So we’re generating a ton of interest on the part of organizations that have not been customers of ours before. Many of them are currently customers of inContact, Five9, or some of the other competitors out there. There’s a lot of dissatisfaction with these first generation cloud offerings and PureCloud is really the answer that a lot of these organizations have been looking for something that does offer the reliability, scalability, all the web based interfaces that these first generation products have not offered. So, I think that’s the most important dimension. Most of these, almost all of these are driven by the contact center. I think just as we saw with CIC through the years and with CaaS, we are selling some incidental unified communication seats. And I think in the early results they’re roughly one-to-one that for every contact center, every Engage seat on average we end up selling a Communicate seat as well. Of course it’s a much smaller revenue component since Communicate only cost a fifth what the Engage does, but it’s a competitive advantage. And that many times we can go into a site and not just be the contact center solution, but the entire enterprise communication solution. We can eliminate the need for a PBX or some other cloud UC service.

Jeff Van Rhee

And with respect to just the Engage seats, I guess, as you look at that forward pipe, can you give resemblance of what an average size customer would look like so we have a sense of where you’re starting here?

Don Brown

We’ve got customers all over the place. As I mentioned, we are dealing with our prospects right now that have 1000s -- 10s of 1000s of contact center agents. And I think that’s certainly exciting. That’s -- some of those deals are beyond the range. CIC really had an upper limit of about 10,000 agents, so it’s allowing us to play in some large deals at the high end. But probably just as exciting for us is the fact that, we now have a very viable offering for the sub-100 seat market, where we really didn’t compete very well with CaaS, largely based on price and complexity. So now we’ve just got tons of 10, 20, 40, 50 seat deals that previously would have gone to some of the other competitors I mentioned.

Jeff Van Rhee

Yes, got it. And then just shifting gears then, you talked about the telephony side obviously with emphasis there. Can you just expand on that in terms of I guess along two -- two perspectives if you will. Just how you think about attach rates? What kind of revenue uplift that can give to a software sale, and then also alongside of that, how you think about the margin impact? What kind of margins you see on that offering?

Don Brown

Yes, well for us its kind of incidental business, although it’s at least the early results aren’t bad. If you consider that a Communicate seat cost 20% of what an Engage seat does and we’re selling them in roughly even numbers, that it means we’re getting an extra 20%. Now the margins on that business aren’t going to be quite as good as on the Engage business. I mean, we have roughly the same underlying cost, but much less revenue coming in, in association. So we have no intention of going out and trying to compete directly as a cloud PBX vendor, we don’t anticipate doing that at all. But we’re very happy to take on that incidental business especially when it gives us a competitive advantage in being able to offer both those capabilities on one contract from one vendor.

Jeff Van Rhee

Okay, great. And then, just one last one for me, on the channel side, as you go all in on PureCloud and put your emphasis as that being your primary offering. Obviously as ramifications for those that have built their businesses around the CaaS and prem side, and then we’ve done a lot to try to increase the payouts and then send those folks to come with you as you make your move to the PureCloud. As you look at those channel partners, you know well what -- how do you think about what percent of those have models that fit the PureCloud world that can -- that can migrate over and make sense for the PureCloud world. Just trying to get a sense of what you’re thinking in terms of channel contribution to sales versus direct as we go forward a year or two out?

Don Brown

Well, I guess, I would just say that we’re kind of trading on our larger partners in terms of existing partners. We have been working with some of our larger partners. Some are -- have been more quick to embrace PureCloud than others. Some of those initial sales actually came through partners and we have some nice deals in the pipeline through partners. So we’re hoping we can get all of our significant partners behind PureCloud. But we’re realistic about it. We know that for some partners, it really just doesn’t fit their business model, I think especially for smaller partners or partners that build their business more on services. We have a number of partners who really have built a business that depends upon a small number of customers and large services engagements with those customers. And that’s not where we’re going with PureCloud. Now we still have CIC, we’re still selling CIC, and we have partners selling CIC. So that maybe a better fit for some partners. But we are also looking at additional partnerships. We’re talking to telco’s around the world and other more referral based partners. So, we’re certainly determined to widen our avenues of distribution. Part of that will happen with existing partners, part of that will happen with new sorts of partner channels.

Jeff Van Rhee

Do you see your professional services line as a growth line over the next two or three years given the easy on-boarding in PureCloud?

Don Brown

Well, I’ve been fond of saying that, at least with respect to PureCloud, we would like to drive professional services to zero. We would like to drive not only our professional services out of business but the need, at least as it pertains to just basic deployment, we want to make that so easy that customers don’t have to pay that deployment tax to us or anybody. And so we would love to get to a point that the services being provided either by our PSO or third party PSOs would be for consulting, and higher value sorts of customer engagement projects and not just for basic deployment.

Jeff Van Rhee

Okay, good. Thank you.

Operator

And we have a follow-up question from Dmitry Netis from William Blair. Your line is open.

Dmitry Netis

Thank you. I have one quick follow-up and maybe a quick comment. On the follow-up, I wanted to see the R&D was up 53%. If you were to exclude the capitalization of software last year, what would the kind of the normalized rate look like? And then actually, how do I think about this R&D growth as we go through the year?

Ashley Vukovits

So, if you just -- if you take out the capitalization from ’14 to ’15, I mean, you still had healthy growth there around 10%. So -- and how you can think of that throughout the year, I think in, just as we’re doing in all aspects of our business, we’re really looking to create operational efficiencies. And so, you won't see us adding the number of developers that we have in the past. We’re really trying to make deal with what we have as well as in all aspects of the business.

Dmitry Netis

Is it fair to assume you’re going to slowdown that pace of R&D stepping up through the quarters because you’ve got all your products out the door now and perhaps even ahead of time as this sort of, the scalability is already there as Don, alluded to. Is that a fair assumption?

Don Brown

Yes. The last couple of years we really had to maintain two R&D teams, both working pretty aggressively, and now CIC is a very mature product, but we’re continuing to enhance it, but we’re kind of over the top of the hill now with PureCloud and we don’t have to continue to ramp where we’re still spending lots of R&D dollars and have a whole long pipeline of features and additional services that we’ll be offering for PureCloud. But we’re not in a position where we’ve got to add tons of developers though the way we had to in the past.

Dmitry Netis

Okay, right. And then quickly on a brief comment, as sort of some of the metrics kind of go away here. I was wondering maybe some of the peers that do have monthly recurring revenue do provide the new MRR or existing MRR growth or bookings. And I understand maybe that’s a little bit too early on the PureCloud, but just to sort of set level set and give us the base as well as maybe the average revenue per customers, as you get a sense of what that may be for the PureCloud would certainly help sort of modeling going forward. So is it something which is better?

Ashley Vukovits

Yes, we get that Dmitry. As soon as it becomes meaningful, we’ll start given at least MRR, I think that’s something that we’ll be focused on internally and that we’ll want to share as soon as that becomes meaningful for PureCloud.

Dmitry Netis

Very good. Thank you very much.

Operator

And I’m showing no further questions at this time. I would like to turn the call back over to Dr. Brown for closing remarks.

Don Brown

Okay. Well, the last thing I wanted to do was just to plug in -- do a plug and a reminder that we will have our Analyst Day on June 6, at our interactions, our global customer event here in Indianapolis, so I would certainly encourage those of you interested to mark your calendars and plan to attend. But thanks everybody and I look forward to talking to you later. Bye.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may all disconnect. Everyone have a great day.

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