Blackbaud Inc

NASDAQ:BLKB

Earnings Call Transcript 2018-Q4

[Operator]

Good day and welcome to the Blackbaud, Inc. Q4 2018 Earnings Call. Today’s conference is being recorded.

At this time, I would like to turn the conference over to Mark Furlong. Please go ahead.

[Mark Furlong, Investor Relations]

Good morning, everyone. Thanks for joining us on Blackbaud’s fourth quarter and full year 2018 earnings call. Today we will review our financial and operational results and provide commentary on our performance in the context of our four-point growth strategy.

Joining me on the call today are Mike Gianoni, Blackbaud’s President and CEO; and Tony Boor, Blackbaud’s Executive Vice President and CFO. Mike and Tony will make prepared comments and then we will open up the call for your questions.

Please note that our comments today contain forward-looking statements subject to risks and uncertainties that could cause actual results to differ materially from those projected. Please refer to our most recent Form 10-K and other SEC filings for more information on those risks.

We believe that a combination of both GAAP and non-GAAP measures are more representative of how we internally measure our business. Unless otherwise specified, we will refer only to non-GAAP financial measures on this call.

Please note that non-GAAP financial measures should not be considered in isolation from or as a substitute for GAAP measures. A reconciliation of GAAP and non-GAAP results is available in the press release we issued last night and a more detailed supplemental schedule is available in our presentation on our investor relations website.

Please also note that unless otherwise specified, we will refer to 2018 results and comparable 2017 results as adjusted to reflect our adoption on January 1, 2018 of ASC 606 related to revenue from contracts with customers.

Before I turn the call over to Mike, I’ll briefly cover our upcoming investor marketing activity, which is available on our investor relations website. During the first quarter, our team will be attending the Raymond James Institutional Investors Conference in Orlando and Stifel Executive Summit in Streamsong. We will also be holding meetings with investors in New York, Chicago, Milwaukee, Houston and Kansas City.

With that, I will turn the call over to Mike.

[Mike Gianoni, President and Chief Executive Officer]

Thanks, Mark. Good morning, everyone, and thanks for joining our call today. I’m pleased to report a solid finish to 2018 as we furthered our strategic initiatives and position the company for long-term success. We continue to shift towards recurring revenue model with our recurring revenue mix comprising 90% of total revenue in 2018, and we continue to accelerate our pace of innovation to digitally transform the markets that we serve.

There’s no question that 2018 was a banner year for Blackbaud’s innovation. The Blackbaud SKY platform has reached a level of maturity that enables us to grow rapidly advance our existing applications and bring new solutions to market, such as our entirely new cloud solution for faith-based communities, expanded cloud solution for higher education institutions, and nonprofit resource management, which is a joint development partnership with Microsoft. And our Blackbaud SKY powered solutions continue to lead the industry scoring high marks with market researches like Forrester, Gartner and IDC.

We’re committed to driving social good innovative new software technology and create lasting value for our customers, employees and shareholders. In 2018, we released our first ever social responsibility report, which provides insight and transparency into our global social responsibility, governance and ethical practices. And I’m pleased with the progress that we’ve made in our program initiatives, which have received national recognition, such as our recently awarded Top Employer for Diversity in America from Forbs. We have a lot to cover this morning, and we want to get to your questions. So let’s get started with the progress that we’ve made against our four-point growth strategy.

The first of our four strategies is integrated and open solutions in the cloud. We’ve created a very high velocity engineering environment that leverages the latest and modern cloud software technology, which is unmatched in our industry. No one else in this space is taking our approach. We made several major innovation announcements in 2018, demonstrating our ability to rapidly innovate, address customer needs and grow our addressable markets.

We introduced our entirely new comprehensive cloud solution for faith-based communities, which will bring together our proven strength in financial management, fundraising, marketing, payments and analytics together in a completely new set of Church Management capabilities. We’re early adopters using the new Church Management Solution today in close collaboration with our product teams, and our Blackbaud SKY platform is enabling us to incorporate real-time customer feedback to rapidly advance platform.

Churches finally have a comprehensive modern cloud solution built for the way they work from a single accountable provider, who can reduce their IT footprint to digitally transform their operations. We also significantly expanded our higher education cloud by introducing enrollment management, learning management, content management, student information and tuition management capabilities.

This broaden cloud will enable higher education institutions to manage the complete student lifecycle from admissions to alumni engagement inside one comprehensive solution. Just like the faith market, this is a massive opportunity for Blackbaud to deliver innovation with a connected cloud experience in a space that’s comprised predominantly of disparate legacy point solution software. And Blackbaud’s cloud for higher education institutions takes full advantage for the rapid innovation, modern user experience and enhanced capabilities made possible by our Blackbaud SKY platform.

Blackbaud SKY enabled us to extend our proven K-12 private school solutions up market to higher education with significantly advanced functionality. Our development didn’t start from scratch and we’ve moved quickly by leveraging pre-existing capabilities available at Blackbaud SKY, that’s the power of this platform.

We also took another major step forward in our partnership with Microsoft, with the announcement of our integrated cloud initiative for nonprofits. This is a joint investment initiative to accelerate cloud innovation in areas that address critical market needs across the mission lifecycle in of nonprofits.

As a part of this initiative, we announced our first jointly developed solution, called nonprofit resource management, which is a breakthrough in helping nonprofits effectively source, track, distribute and measure the impact of their resources across core business processes for managing the distribution of material goods to financial and human capital distribution.

The nonprofit resource management solution suite is currently in development in collaboration with early adopters. The solution will be sold jointly through Blackbaud and Microsoft partner and sales channels and will work seamlessly with Blackbaud Solutions, providing a connected experience for our customers. This is another step forward in an evolving partnership between Blackbaud and Microsoft to jointly develop, co-market, and co-sell innovative software technology that will advance the industry and an interesting go-to-market optionality for us that we didn’t previously have in the past.

Finally, I’m excited about our recently announced acquisition of Plano, Texas-based YourCause, an industry leader in enterprise, corporate social responsibility and employee engagement technology. YourCause stood out as an innovative, flexible and scalable software provider with an impressive customer portfolio, including Fortune 500 companies and small businesses alike, along with exceptional customer satisfaction and retention.

Hundreds of companies like Dell, AT&T and Samsung have chosen YourCause to enable over 8 million people to process roughly $250,000 in donations every business hour. YourCause have coordinated, tracked and rewarded more than 30 million volunteer hours for its customers. Our combined footprint and corporate social responsibility, employment engagement positions us as the global industry leader in providing cloud solutions for both nonprofit organizations and for profit companies committed to social issues.

Adding YourCause’s innovatives and differentiated capabilities at workplace giving and volunteering to Blackbaud’s unmatched cloud software platform, data intelligence, services and expertise and philanthropy in engagement is a game-changer in driving effectiveness for companies and the broader social good community.

This leads me to our second growth strategy, which is to drive sales effectiveness. Selling modern, integrated cloud solutions that are purpose built for our customers’ needs is a key competitive differentiator for our sales teams. The transformational change that’s taken place in R&D, highly aligned with our selling strategy by design. Our sales account executives are now leading with a total solution selling strategy by vertical, focused on recurring revenue and driving more products per customer, higher ASPs and overall increase customer lifetime value. As you know, we’ve been steadily pouring the foundation, to develop a highly productive and scalable sales model, and we start the second half of 2018 ramping our sales hiring more significantly than cash trends.

I am pleased to share that we increased our total direct sales headcount by roughly 20% in the second half of 2018, which is more than doubled our historical pace of annual hiring. We’ll continue investing into sales for 2019 and beyond to better address this massive market opportunity and the focus going forward will be adding additional sales headcounts, improving productivity in a greater focus on adding net new logos. We make big strides over the course of the year to simplify our program that refine our methodology and approach in a uniform way to better enable our salespeople with process and practice.

Our sales transformation structure is largely done and we plan to carry that momentum into 2019 with our expanded sales organization. We had some really terrific wins in 2018, adding to our growing customer base of over 45,000 customers.

I obviously can’t cover them all, but I wanted to give you a sense of momentum that’s building with customers, choosing to partner with Blackbaud, leaving higher education institutions, like Clemson University, some of the largest K-12 private schools in America, like the Punahou School in Honolulu, [indiscernible] organizations like George Bush Presidential Library Foundation, Boston Bruins Foundation, large healthcare organizations like Dartmouth-Hitchcock health, nonprofit correlations like the United Way of Portland, and Faith, one of the largest catholic diocese in United States has selected Blackbaud to part of their organization, inclusive of several hundred cashes in over 100 K-12 private schools.

Our partnership with Microsoft is gaining momentum as well, with Microsoft introducing us to new joint selling opportunities like Ducks Unlimited, we chose to partner with both Blackbaud and Microsoft to advance their mission in organizational objective.

Now let’s turn to our third strategy, which TAM expansion. We’re continuing to expand our TAM engineering your adjacencies with acquisitions and product investments. We’ve been executing this strategy for several years now, primarily expanding TAM through acquisitions until 2018, which is a banner year for Blackbaud innovation. We’ve make three organic TAM expansion announcements, introducing the Blackbaud Cloud Solution for Faith Communities, our Extended Cloud for Higher Institutions, and Nonprofit Resource Management with Microsoft. We’re demonstrating that we’re now able to organically build the not just required incremental TAM. And these solution introduction added approximately $2 billion to our adjustable market. We also acquired Reeher in the second quarter of 2018, the bolster Blackbaud’s extensive performance benchmarking capabilities.

And we’re very excited about the recent acquisitions of YourCause, which closed in the first business day in January 2019, and adds another $0.5 billion of our TAM. Our total adjustable market now stands at over $10 billion, and we remain actively in the evaluation of opportunities to further expand our TAM through acquisitions and internal product development. Our final strategic initiative is to focus on operational efficiency, the strength in the business position us for long-term success. We continue driving towards a more scalable operating model that creates efficiency and consistency to how we execute through infrastructure investments, productivity initiatives and organizational realignments.

In 2018, we executed a comprehensive workplace strategy to better align our organizational objectives with our geographic footprint. We designated Charleston, Austin, London and Sydney as our hub locations, and we are leveraging a more flexible office strategy to replace and upgrade some more existing offices and expand our footprint into new locations for customer-facing roles. This operates our flexibility, allows us to all of our business to better meet goals of employee customer needs. Overall, the key for us is optimizing our office utilization, improving our geographic sales coverage and enhancing our employees daily experience to improve productivity and effectiveness. We continue this initiative into 2019 and accept to be largely complete by the end of this year.

Overall, I’m pleased with the continued transformation in the business and shift towards reoccurring revenue. And I’m particularly excited by the accelerated pace of innovation that we’re delivering for our customers and the reaction in the market, our new cloud solutions have significantly expanded our addressable markets and cover a greater share of customers IT spend. Our commitment to develop a fully integrated end-to-end cloud are game-changers for the industry and a massive opportunity for Blackbaud.

I’ll now turn the call over to Tony to cover our financial performance in greater detail before we open it up for Q&A. Tony?

[Tony Boor]

Thanks Mike. Good morning, everyone. Over the course of 2018, we strengthened the business, delivered greater value to our customers and better positioned ourselves for future growth and scale. Our fourth quarter results allowed us to exceed the mid-point of our updated full year revenue guidance, and exceed the high-end of our updated ranges for both profitability and cash. I’ll refer to yesterday’s press release and the investor materials posted to our website for the full detail for the full details of the quarters and the full year financial performance. Today I’ll focus on key highlights, so we can get to your questions.

We continue to successfully reduce the mix of one-time services and other revenues which is positive for us long-term that creates a significant drag on our total company revenue growth in the near term. One-time services and other revenue represented only 10% of total revenue mix and declined $6 million in the quarter which is a 21% decline versus Q4 of 2017. We are now selling a portfolio of modern cloud solutions, which is driving this shift away from one-time services. Recurring revenue mix represented 90% of total revenue, which is 260 basis points higher than Q4 of 2017 and 2.8% growth on an organic basis.

On a full year basis, we delivered $851 million in revenue, which exceeded the midpoint of our updated guidance and represent 7.6% growth over 2017, or 2.7% on an organic basis. Recurring revenue represented 90% of total revenue, which is 300 basis points higher than 2017 and 5.6% growth on an organic basis. One-time services and other revenue represented 10% of total revenue mix and declined $18 million, which is a 17% decline versus 2017. We successfully drove an accelerated decline in our professional services business, and that rate of decline exceeded our initial expectations from the beginning of 2018.

Turning to profitability, our fourth quarter gross margin fourth quarter gross margin was 58.8%, which is a 50 basis points increase versus Q4 of 2017. For the full year, our gross margin was 60.8%, which is 90 basis point improvement over 2017. We generated full year operating income of $171 million, representing an operating margin of 20%, and diluted earnings per share of $2.59. Both operating margin and diluted earnings per share were strong and exceeded the high end of our updated full year financial guidance.

It’s important to note, that our operating margin performance was inclusive of our 2018 investments into innovation like our entirely new Faith Cloud expansion of our Higher Education Cloud, Integrated Cloud initiative with Microsoft, acquisition of Reeher, an investment to ramp in sales hiring that we began in the third quarter adding roughly 20% to our sales headcount year-over-year.

Moving to the cash flow statement and the balance sheet. In Q4, we generated $51 million in free cash flow. We continued making necessary innovation and infrastructure investments to support our move to the cloud, amounting to $2 million in CapEx, primarily associated with our new headquarters and investments and infrastructure and a $11 million for capitalized software development. For the full year, we invested $15 million in CapEx for property and equipment, and $38 million for capitalized software development, which landed within our expectation of $45 million to $55 million for the full year.

Our full year free cash flow was $149 million, which exceeded the top end of our updated guidance range due to over performance and profitability. Free cash flow increased $11 million or 8.2% when compared to 2017, and our free cash flow margin of 17.5% for the full year was roughly flat year-over-year. We didn’t pay cash taxes in 2018 and received a refund at the amount of roughly $7 million. During the quarter, we paid out $6 million cash dividends to shareholders, and ended with $356 million in net debt.

Our capital strategy calls for a debt-to-EBITDA ratio of less than 3.5 times, at end of Q4, we stood at 1.9 times. I’ll note that this excludes the acquisition YourCause, which closed the first business day in 2019. Having closed the acquisition before year-end, our debt-to-EBITDA ratio would have been approximately 2.6 times.

Now let’s turn to 2019. We’re guiding to non-GAAP revenue of $880 million to $910 million. Non-GAAP operating margin of 16.7% to 17.2%. Non-GAAP diluted earnings per share of $2.11 to $2.28 and free cash flow of $124 million to $134 million. We have several key assumptions contemplated in the development of our guidance. The acquisition of YourCause is included, and expected to be accretive to revenue and dilutive to profitability and cash flow for the year. From a revenue perspective, we’re expecting the drag for one-time services and other revenue to continue for our third consecutive year, and anticipate the rate of year-over-year decline to accelerate to roughly 25%.

YourCause is expected to contribute $20 million to $25 million in annual revenue, and will be excluded from our organic revenue calculations in 2019. We are taking a conservative approach with the inclusion of YourCause in our guidance, which is closer to the low end of that $20 million to $25 million range, as we anticipate that YourCause will cannibalize some of our corporations and foundations revenue as we integrate the business into our core offer.

From a profitability and cash flow perspective, 2019 as an investment year to better position the business for accelerate growth and long-term success. We aggressively ramp sales hiring in the second half of 2018, and in 2019, we will incur the full year expense impacted those hires. We expect to continue this heightened pace of investment to support the future growth of the business. We’re also investing in innovation for our customers. We in AdSense created two entirely new businesses with the announcement of our cloud for faith-based communities and expanded cloud for higher education, and we acquired another with the YourCause acquisition.

Our estimate for 2019 combined capital expenditure is expected to be $45 million to $55 million, which is roughly equivalent to 2018, and primarily consistent cost required to the capitalized software development. We’re anticipating CapEx to decrease year-over-year with a fit out our new global headquarters now behind us. As Mike mentioned, we’re continuing to execute against our workplace strategy which we’ve accelerated into 2019. We’re currently expecting to incur before tax restructuring costs associated with these restructuring activities of between $8.5 million to $9.5 million of which $5.4 million has been incurred through 2018 and we expect the remaining costs to largely be incurred in 2019.

Our updated estimates reflect the more aggressive actions were taken to relocate and consolidate some of our offices during 2018. We expect to gain operating efficiencies beyond 2019 with future annual before tax savings of between $5 million and $6 million per year beginning in 2020. Our non-GAAP tax rate will remain consistent with the 2018 rate of 20%. And we’re expecting to pay minimal cash taxes in 2019. Our free cash flow will be impacted from the investments we’re making in the business.

The 2018 cash tax refund of $7 million, million, which will repeat in 2019, accelerated restructuring associated with our workplace strategy, and the impact from acquisition of YourCause. Our deployment of capital strategy hasn’t changed. We’ll continue to pay a dividend, invest in our growth and operating initiatives, and continue paying down debt providing capacity for expansion opportunities.

From a new accounting standards perspective, we will be adopting ASC 842 for leases and Q1 of 2019. We expect that the impact to our P&L and statement of cash flows will be minor. The largest financial impact will be related to recognizing lease liabilities and right use asset from the balance sheet per substantially for all of our leases.

I’ll close by saying that we continue to execute against our strategic plan. We’re maintaining our disciplined approach to balance investments that drive growth and profitability. And we’ll continue to execute on our capital deployment strategy to maintain a strong balance sheet, return capital to shareholders, and create growth and scalability.

With that, I’d like to open up the line for your questions.

[Operator]

Thank you. [Operator Instructions] We will now take our first question. Please go ahead caller, your line open.

[Unidentified Analyst]

Hey, good morning, guys. Thank you for – thanks for the question. So I want to tackle some of the TAM expansion here first. And you’re going after two markets that that seem sort of drastically in need of some innovation, so right place, right time, but also pretty big markets. And so I’d love to hear a little bit about, as you think about these investments, strikes me that it’s not just a one-year investment. And the margin guidance you laid out for this year, certainly positions this as an investment year. And Tony, you talked about getting some leverage out of sales and out of facilities going into next year.

I’d love to hear a little bit more about how long we ought to think about some of the margin suppression sort of staying down in this level below historical margins. Is that a type of approach that we ought to think of being a couple years given the type of opportunity you have here in the sales edge you need and the innovation that needs to happen? Or is this truly sort of a one-year gap year and we ought to expect as we think a little bit further out to leverage will start to materialize even given this TAM expansion?

[Mike Gianoni, President and Chief Executive Officer]

Hey, Tom, it’s Mike. Yes. From an investment standpoint related to TAM, we have – I think, you know really expanded our TAM in the last several years by going much winder in many of our vertical markets and that’s what’s happening here. So in the faith-based market, we announced that new cloud platform there several months ago, and it is just a massive opportunity. And you’re right on your question that market is just in need of innovation. And I’ve mentioned in my prepared remarks, just about one of the deals that we signed for this new platform, which includes hundreds of churches and over a hundred K-12 schools. And that really pulls our not much of our portfolio into that, not just the faith-based, but the K-12 portfolio, so big TAM expansion in faith-based.

And in higher ed, what we’re essentially doing is we’re taking that K-12 platform that runs schools, for a while now we’ve been adding capabilities for universities. And that is the new higher ed platform, TAM expansion as well. It’s important to note, in both of those markets, faith-based and higher ed, we’re already there. We’ve been providing fundraising and financial solutions and scholarship management solutions in higher ed and fundraising and financials in faith-based. We’re just expanding in new and existing base to get a lot more TAM and a lot more IT spend.

And in many cases, what happens if the customer signs up and these solutions eliminate 12, 15 stand-alone software providers with one cloud solution, so really interesting long run investment opportunities for us through these TAM expansions.

[Tony Boor]

And then, Tom, I hit on the margin side of things. We made a stairstep increase as we spoke about and plan for last year on the sales and marketing and the innovation side of the business. We were relatively flat on the sales headcount through mid-year and we started to ramp in Q3 with the majority of hitting us more so in Q4. And we ended up, you’ll see this in the K, we ended up 84 net heads up from a sales perspective, so roughly 20% growth where historically we’ve grown sales headcount at about 10%.

So we kind of doubled the rate and we’d expect to continue that into the future. So there will be a heightened investment on that front. We certainly had to increase our R&D investments for innovation as well with the build out of these new solutions and to increase the TAM as Mike just talked through.

The payback on those, I’d expect that we will start seeing some payback on the sales investment front late 2019 much more so in 2020, as we get the folks on board and trained, build pipelines, closed deals and then ratable revenue recognition. We’ll see more of that impact starting to come in 2020, but maybe a little bit later yet this year as well.

Innovation investments, those products are in market being tested and/or launching this year more so towards the second half of the year. But we’re already seeing some good traction. But again, we’ll see some impact of that probably late 2019, but much more so in 2020 and beyond. So those will be favorable I think from a growth perspective in the business.

The other side is one-time services, strong 17% prior year and the year before. We’re accelerating that with a lot of the initiatives we have in place and we think it’s going to shrink closer to 25% this year. And I think it probably bottoms out either late 2019 or in 2020. And from that point forward, I’d hope we actually don’t see that same kind of drag on the business and may actually start seeing some growth again in one-time, which will help our total growth profile probably in late 2020/2021.

With the heightened growth that we should get from all of those investments, then I expect we have leverage opportunity, better leverage opportunity in the business. The other thing is that increase in the sales headcount, this new stairstep, kind of 20% rate, should start funding the future increases in sales once they’re fully productive. So once we get to the new norm, I would expect we’ll start seeing some benefits and they will be able to fund the future sales ramps.

The other things that have improved margins over the longer-term, we’ve gotten a little more aggressive. We talked about in the script on our facilities optimization, workforce strategy. So we expect to take a little bit larger of charges between now and the end of the year. But we’ve also increased our annualized estimate for savings. So we’re ramping all the way up to between $5 million and $6 million a year in expected annual savings from this facility’s optimization work, which we should start seeing in 2020 and beyond. So that’d be very favorable to margins.

We also are still double paying with the move to the cloud on the infrastructure side of the business. So we’re still paying for our data centers and for third-party cloud. So as we finish that transition over the next couple of years, that should add to margins, as well as just all the other things we’re doing to gain efficiencies and leverage in the business. So I’d expect kind of a gradual stairstep improvement in margins in 20 and out years.

[Unidentified Analyst]

Great detail in there. Thank you, guys. I’ll jump back in the queue.

[Tony Boor]

Thanks, Tom.

[Operator]

We will now take our next question from Brian Peterson of Raymond James. Please go ahead.

[Brian Peterson, Raymond James]

Hi, gentlemen. Thanks for taking the question. So, Tony, maybe one for you. I just wanted to make sure I understood the linearity of the investments and how they might translate into 2019 because it looks like the sales and marketing expense at least sequentially wasn’t up that much. So were there other sources of savings maybe in the fourth quarter or just better execution that allowed you guys to have the OpEx beat this quarter? And then how should we think about those investments looking at margins through 2019? I know you guys don’t guide quarterly, but just trying to understand how that could play out over the course of the year.

[Tony Boor]

Yes, Brian. As I sparked on Tom’s question there, the headcount was ramped very late in the year. And so we didn’t have nearly as much impact on the numbers as you would expect to see. So that, full year bow wave will start to hit us in Q1. So you’ll see that there. Plus then our plan continues to ramp in sales headcount as well, and innovation investments will hit us. So I think if you look more so at kind of the increase in the sales costs that you saw in Q4 in the detailed numbers and plan for that to continue to ramp, that’s where the majority of investments going to be as in the sales and marketing.

The second kind of biggest piece of the 300 basis points will be in innovation, so in R&D and in the net expense that we record their net of the capitalization. The Q4 numbers as always, the team pushed really hard, did a great job to control costs in the second half. After we had updated the guide, the team pushed hard to make sure that we did everything as we’ve done in prior years. Had a good Q4, I think there were some favor ability certainly within the expense base of us just being very focused on it, much like we saw at the end of 2017 when we had a much heightened kind of EBIT in the fourth quarter. So that would have offset some of that impact you’d seen in the P&L.

[Brian Peterson, Raymond James]

Got it. Maybe just another one, I wanted to hit on the NXT upgrades. And, by my math, that’s actually been a pretty key growth driver for you guys over the last few years. As we reached the halfway point of that migration, how should we think about the incremental growth opportunity from that going forward?

[Tony Boor]

Yes.

[Mike Gianoni, President and Chief Executive Officer]

Yes. I mean, that’s been a good program and it just continues to be a good program. We keep evolving that platform. In fact, the faith-based cloud announcement we’ve made several months ago and the way we’re driving that whole church management solution is sort of a derivative of NXT, if you will. So it’s completely bundled at the core architecture level. So, it’s been expanded to really drive that vertical solution. So the products going well, the platform now really drives based on the SKY architecture, drives a lot of capabilities and it’s continuing to expand.

[Operator]

Thank you. We will now take our next question from Rob Oliver of Baird. Please go ahead.

[Matt Lemenager, Baird]

Hey, guys. Good morning, it’s Matt Lemenager on for Rob. Mike, I have a question on YourCause. How much integration work needs to be done to kind of align that with Blackbaud’s core products and then the go-to-market for YourCause? Will all the reps be carrying it in their bag of products or would that be kind of limited to an initial set of reps and expand it out later? I think Tony mentioned, there may be a little bit of cannibalization in that $20 million to $25 million guidance number for the full year.

[Mike Gianoni, President and Chief Executive Officer]

Yes, sure. So, YourCause, we’re using our playbook we’ve used before, where the YourCause business is a business unit within Blackbaud. What that means is there’s not a ton of integration required. We will integrate quickly the corporate functions. We have already expanded the sales team from another part of the company that was in a similar market, so we’ve already added that to the YourCause team, but the YourCause leadership team and business unit will drive their business forward and we’re just adding resources and reducing some of the burden and cost of corporate functions, if you will, and internal IT and things like that.

The really cool fit with YourCause is it gives us a very large global footprint with businesses in a very near adjacency, which is giving and volunteering, and so it’s very much a close near adjacency for us. And their platform has provided donations to over 100,000 nonprofits and there are over 300,000 nonprofits globally registered in over 170 countries. And as I mentioned in my prepared remarks, there’s over 8 million employees on the platform that give almost $250,000 every business hour.

So it’s a big reach and it creates an interesting opportunity for more of a network effect for us, given the number of nonprofits that have received donations, arguably many are not Blackbaud customers. So it’s a really great fit, really great platform, nice near adjacency for us and we’re just investing in a larger go-to-market as we speak.

[Matt Lemenager, Baird]

Great, thanks. And if I could squeeze in a quick follow-up. Tony, as we look at the 2019 guidance, is there any change in the assumption for renewal rates or I guess turn rates at all, that’s included or embedded into the 2019 guidance? Thank you.

[Tony Boor]

Nothing that we guide to, Matt. So we would have contemplated and the normal impacts have just – where we are with relation to our sunset plans, migrations and impacts those have, all of those various things that are going on within the business would have been contemplated in there, but no specific guidance that we’ve given on retention.

[Operator]

Thank you. We will now take our next question from James Rutherford of Stephens, Inc. Please go ahead.

[James Rutherford, Stephens, Inc.]

Hey, good morning, Mike and Tony. Mike, my first question is around sales productivity. I know this has been a big focus for you and the team. Do you think you’re done with some of the big changes in territories, comp structure, et cetera, that you’ve done? And maybe just provide some additional commentary around how you think those initiatives are going and what you expect kind of for the 2019 sort of per rep billings growth directionally?

[Mike Gianoni, President and Chief Executive Officer]

Sure. Yes, we’ve made a lot of changes in the last several years in sales to create one global selling engine, if you will. And, yes, most of those changes are behind us. We just made quite a few changes to start of the year this year, mostly around the number of folks we just hired in the last several months, as Tony mentioned, up 20% headcount, and a couple of new cloud announcements that really expanded our TAM and addressable IT spend in those verticals.

So, but most of the changes are behind us. We now have one comp plan in the world from company for the first time ever, and it’s really focused solely on driving recurring revenue. We had to consolidate multiple plans over the last several years. And our sales teams, as you might know, are now fully focused in vertical markets. They are separated into hunters and farmers, back to base and new logo, if you will. And those changes have been coming for a long time.

But, yes, structurally we’re done. Now it’s just driving continued execution and productivity. There’s a whole new management. Playbook that’s in place, lots of new hires. So structurally, we’re done, now it’s just about continuing to drive productivity and continuing to add headcount.

[James Rutherford, Stephens, Inc.]

Okay, helpful. Thank you. And then, Tony, my second question is around the implied organic growth guidance for 2019. So recurring revenue growth organically was 5.6% in 2018 and 2.8% in the fourth quarter. So based on the math I’m doing what you gave us around one-time services declines and the YourCause contribution 2019, it seems like the full year 2019 recurring revenue organic guide is around 5% or better. So correct me if I’m wrong there, but that’s an acceleration over the 2.8% in the fourth quarter. So just curious, what gives you confidence in that sort of implied organic growth acceleration from the fourth quarter?

[Tony Boor]

Yes, I think your math is roughly in line, assuming, we end up having the decline in one-time and then where we gave info on YourCause guidance kind of to the lower end of that 20 to 25 just because of the potential for some cannibalization early on. I think the confidence, a couple of different fronts. We did a – we took a different approach to the budgeting and forecasting process this year on one-time. As you know, that’s been a really hard and tough area for us to get right. There’s just a lot of moving parts there. As we move more to the cloud, we need less implementation. We’re certainly doing less customization. As more of our base moves to the cloud, they’re doing less integration with other third-party solution sets as well. So there’s a lot of pieces on that front and we’ve started to embed more services.

We are also changing a lot of the offers that were one-time in the past to be recurring. So we’ve started to sell a lot of the training and learn-type stuff in a subscription, right along with RENXT, FENXT, on products, et cetera. And so that’s moving things out of one-time to recurring. So a lot of things that are affecting that one-time services number. We took a completely different approach this year to forecasting that, feel really good that we’ve got a better handle on it and that will take a lot of the variability out of our guide on the revenue front.

Then on the recurring revenue side, it’s a lot more predictable. I think the place we have – had any difficulties really been on the transactional side of the business. And so that one done a lot of work as well. I feel good. We’ve got the right process and taking the right approach. The growth is really driven by our investments. So we feel good. Like Mike said, we’re through all this transition stage and all the noise that might create. And so really now it’s about how do we keep improving productivity, adding headcount. We feel good about our ability to add sales headcount based upon what we did in Q3 and Q4. We feel good about how quickly we can train and ramp those folks and we monitor that very closely. I think the new processes is going to help our productivity, all those things should drive growth.

And so based upon the investments made last year and planned investments this year, the added TAM, the launch of the new products for faith and higher ed and Microsoft partnership, all those things lead to, we should have gotten a point where we’re largely at bottom now and start seeing acceleration going into 20 years is our intent and plan. And then just one clarification to make sure everybody’s aware, YourCause will not be counted in our organic growth for 2019. So we will have a benefit of that higher growth profile in 2020 when we get there, but it is not included in our planned organic growth in 2019 for our policy.

[Operator]

Thank you. We will now take our next question from Justin Furby of William Blair & Co. Please go ahead.

[Justin Furby, William Blair & Co.]

Hey guys, thanks for the question. Maybe just to start off, going back to the NXT, the migration. I think you said recently you’re a little bit over half of the way through that. Can you just remind us, Tony, a few years ago you talked about 50% to 1.5x to 2x lift on that maintenance. What does that look like more recently and sort of how you assume that to play out this year and for the next few years? And then I’ve just got a quick follow-up for Mike on YourCause.

[Tony Boor]

Hi, Justin. We are more than halfway through and so from a comparative growth basis, obviously, we won’t see the level of support to growth going forward. Now we’re past the top of the bell curve on that side of things. The uplift on those where we’re still truly selling those migrations from the base and moving them over, we’re still seeing good uplift. We’re now on the backside of the curve and starting to evaluate programs more focused. I think we’ve talked about this before, more focused on retention for the long run and getting them converted over.

And so we started to begin some programs that are more migration focused versus sales, if that makes sense; where it’s more intent on getting them to move to the new platform, so we can keep them for the next 20 years versus merely focused on the potential uplift on the sale side. And so I do think that average uplift we saw through these first few years, we’ll start to decline now that we’re on the backside of the bell curve as we move with more focused towards retention. I think we’ll see more aggressive programs that help with the migration et cetera. So I do think it creates a tougher compare from an organic growth perspective going forward, now that we’re on the back side of that curve.

[Justin Furby, William Blair & Co.]

Okay. That’s helpful. And then, Mike, just one thing I missed in all of this with the YourCause acquisition. Can you just sort of back into the incremental TAM. I know you acquire the company MicroEdge a number of years ago, that I thought to be one of the primary competitors to YourCause in the space. So what’s incremental for you in terms of this acquisition and do you continue to invest on the on the MicroEdge platform as well? Thanks.

[Mike Gianoni, President and Chief Executive Officer]

Yes. The incremental TAM is a $0.5 billion. It was with MicroEdge, there was one small product that was a direct competitor to YourCause, not MicroEdge in its entirety. And the TAM expansion against $0.5 billion.

[Operator]

We will now take our next question from Rishi Jaluria of D. A. Davidson. Please go ahead.

[Rishi Jaluria, D. A. Davidson]

Hey, guys. Thanks for taking my questions. Tony, I appreciate the granularity on the guidance. I wanted to circle back to that, so some also getting something in neighborhood of 5% to 6% organic recurring growth next year. Now, you said in the past that this market is growing at 7%, if I’m not mistaken. So just help me kind of understand, why are your organic recurring growth rates slower than the market? Is that a function of maintenance being dragged and still converting maintenance to our subscription or there other factors there. And then I’ve got a follow-up.

[Tony Boor]

Yes. Rishi, there is a lot of things to play that we kind of finish executing gives the strategy we’ve rolled out, several years when Mike came on board. Some of the pieces that are still pull against the growth are going to be the sunsetting of the products, the migration of the old legacy products, and those typically will have heightened churn because you put those customers in market when you’re trying to move them to your new platforms like we’re doing on RENXT and FENXT etcetera. The transactional business certainly provided more lift in the early years. And so has that base has gotten bigger and we’ve penetrated more of the base, we’ve got to replace that growth rate with accelerate growth elsewhere.

Certainly from a total growth rates, you’ve got one-time services that has dropped off dramatically as part of our strategy, as I answered it, I think it was Tom’s question earlier, the prior two years we’ve seen a 17% decline each year in one-time services, we’re expecting that to be a 25% decline. I think the key for us as well as the base has gotten a lot bigger and we had kind of stuck to that same number of sales headcount. So I think we were trying to implement a lot of the other pieces of our strategy in the last key piece was this investment in sales and marketing that we really have just begun here in late 2018. And so I think the ramp sales, the increased productivity and sales, all of those things, the expansion of TAM that we’re doing should bode well for future growth once we get to these final last year or two of implementation of the strategy.

[Mike Gianoni, President and Chief Executive Officer]

The other thing to – the TAM expansion is pretty significant, because if you think about the products and platforms we’ve announced the new cloud solutions, we’re covering – we’re going from becoming a departmental player to an enterprise in those verticals, which covers a lot more product and IT spend than before in verticals that we did in for a while. So it is not just new verticals, it expanded within the vertical. We’ve also grown the customer base quite a bit. We announced in our prepared remarks, excuse me, that we have over 45,000 customers now and we’ve got a significant part of our sales team focused on new logos. Wish you go back several years ago that was not the case. So the combo driving sales productivity, launching new headcount, focus on new logos is fairly new for the company and footprints then expanded quite a bit.

[Tony Boor]

Rishi, one of the other things that we’ve talked about a bit with folks is, we have effectively stood up two branding businesses so it’s two startups, and so a lot of these investments we’re making when you think about having to build out a sales team for this new faith channel, although we solved there, we’re expanding our sales team substantially, but that product doesn’t launch until the second half. And so rev rec wise, we got to get the team higher, we’ve got to get, I’m trying to get in the field, we got to start building momentum in the space for the new product and then new product doesn’t launch until later in the year. And so in 2019 you’re just not going to see a huge contribution for those startup businesses. Much like what you’d expect with any startup. But we’ll start seeing real benefits. Hopefully exiting the year and certainly in 2020 and 2021.

[Mike Gianoni, President and Chief Executive Officer]

Yes. And I would also add one thing. As we’ve talked a little bit about customer wins in my prepared remarks I’ll just – the one market of faith-based, we have been really growing the success in that market for allowing now and just announced that cloud solution several months ago. But a significant proof point in what we’re doing there is what – I said in my prepared remarks, we had a very large institution permit, hundreds of churches and over hundred K-12 schools, contractually, that is a big commitment. It is a really, I think, a good indication of proof point on what is about to come from us in the faith-based market.

[Rishi Jaluria, D. A. Davidson]

Got it. Thanks. That’s helpful guys. And then just really quickly on the jointly developed NRM solutions with Microsoft. I know it starts to – to launch later this year, if I’m not mistaken, but can you just give us a sense for what is go-to-market and potential revenue share look like between you and Microsoft?

[Mike Gianoni, President and Chief Executive Officer]

Yes. It’s jointly developed and jointly brought to the market. So we’ll be selling it, they will be, and we will be together. We have a lot of go-to-market initiatives just starting off with Microsoft, that one happens to be one where we are codeveloping the product, it is basically – if you think about the supply chain management product for large global profits. But we’re going to the market with them in education now, higher ed, nonprofit space and other markets. So it’s still very new for us, both companies to go-to-market together.

Microsoft small is a very complementary model for their partners, including Blackbaud, where – their teams are compensated on things like Azure consumptions. And so there is a revenue share when we go-to-market because it’s an Azure consumption model that they use. And as we continue to shift our workforce with Azure, it is a complementary field compensation model, which is great for us and for them.

[Operator]

We will now take our next question from Kirk Materne of Evercore ISI. Please go ahead.

[Kirk Materne, Evercore ISI]

Hi, thanks very much. Thanks for taking the question. Mike. given your standing up, as Tony mentioned, sort of two new businesses around these bigger TAM opportunities, what’s the payback time? Are you expecting in terms of getting sales – had new sales had got ramped up, meaning is this sort of a nine to 12 months ramp for them as they build out pipeline. You obviously have to introduce yourself to new customers. Just trying to get a sense on how you’re thinking about sort of when they get to being fully productive.

[Mike Gianoni, President and Chief Executive Officer]

Sure. It’s a pretty wide gap between phone sales and enterprise field sales as far as ramp. On average, the ramp time is less than nine months if you look at all the jobs aggregated together. The other side of that is revenue ramp for these two new cloud solutions, they don’t even go live until the back half of this year. So revenue ramp will take a while, but we’re closing deals now as we speak and we early adopter customers using the platform now.

[Kirk Materne, Evercore ISI]

Okay. And then just one quick one for Tony. Tony, obviously over the course of the year, the organic recurring revenue growth rate decelerated. And just want to get a better understanding of that. I assume some of the transactional business that you guys referred to your last time – last time we talked and you took down the numbers. Is there anything else going on? I really want you to bring on new sales guys, that are just re-cut territories and there might be some pause in that. I just want to – I guess have a better understanding of that, because I think that helped instill further confidence in your recurring revenue growth assumptions for next year. Thanks.

[Tony Boor]

Yes, absolutely correct. There’s been – there’s certainly been some change management that we had to work through on the sales and marketing front. As Mike alluded, we’d been working on that one for about three years now. We stood up customer success. We’ve really changed the process and approach. I went to that hunter-farmer or back to base prospect model. We’ll move reps out into the field that were largely offset in Charleston. We’ve changed roles, we’ve changed the whole management process, territories. There’s been a quite a bit of change that we’ve worked through over the last three years. I think we’re finally going to be to the point this year in 2019, we start seeing stability, so our real focus there will be ramping additional heads and getting more productivity out of the existing base.

We still think there’s a lot of opportunity to improve the productivity of the existing base of 500 plus reps as well. So we have high hopes for that to help drive more growth over the coming years as we make improvements there. The other side of things outside of just the change management that we had to deal with, you spoke about obviously transaction business last year was a bit of tough, compare year 2017, we had some positive impacts from the elections that carried over into Q1. We didn’t have as many one-time events. We had some change in consumer giving patterns.

We talked about smart tuition, mix of parents and a fluency, obviously UK market and Brexit, just all the different things going on in the economy, the tax reform. It’s hard to put a number on any one of those individually, but overall, certainly a tougher year last year on the transaction side that pulled down our recurring revenue growth. And other thing is we’re still working through the migrations and the sunsets. And as we’ve talked about, we are not building feature parody and all of those. And when we shut those products off, we lose customers. We put customers in market when we are going to them make decisions on migrations to the next gen platforms.

And as you saw last year, we actually lost a point from a retention perspective and that’s impactful. We do expect to see a retention bottom out and shift back the other direction as we get through these programs here over the next two to three years. And so that’ll be a favorable impact on growth as well. But that’s certainly been a drag on us over the last three or four years as we’ve implemented this strategy also.

[Operator]

Thank you. We’ll now take our next question from Ryan MacDonald of Needham and Co. Please go ahead.

[Ryan MacDonald, Needham and Co.]

Yes. Good morning, Mike and Tony. My question is around sort of on top of that transactions business and sort of obviously 2018 like you mentioned it was a bit of a rough year there for a number of reasons. As you’re looking down to 2019, can you talk about sort of what the assumptions you’re building in for the transactions business in 2019 and sort of what the expectations are now, particularly with just giving and when that should be going live in the U.S. and maybe what – how that can help with the transactions business in 2019 in U.S.

[Tony Boor]

Yes. Ryan, this is Tony. I think from an assumption perspective as we spoke about even last year with the update guide, the number of customers we’ve been adding, the number of customers processes, the number of large customers, high value customers, we’ve added to the payments platform has all been trending positively. It was really this trend and consumer behavior and a lower average donation size that we saw. And part of that, it’s hard to put your hand on what drives that, much of that can be driven just by the fact that we had less one-time kind of major incidents that drive big spikes in giving.

And so we’ve got some pretty detailed forecasting tools at a product and customer level that we use and some seasonal trends that those levels. And so we build that out based upon all the kind of current trends that we’re seeing and the rates of adding new customers and time to go live and penetration rates and the average donation size. So we feel good about it from that perspective. There’s just more volatility obviously in the transactional side that we can’t predict. We could have a really good year this year just depending on where consumer sentiment comes in and things like UK market.

So that one, I feel good. We’ve assumed things as accurately as we possibly can based on – now they’re just giving launch, was always a big plan as part of that acquisition for the U.S. market. And that will happen this year. So team is progressing on that front very well. Again timing of that launch and then ramp time, it won’t have a huge contribution in 2019, but it’s just another one of those areas of growth that it should provide some growth in 2019 and help hold that recurring revenue growth rate up, but certainly 2020, 2021, 2022 would expect to see really good things on that front as well along with faith and education cloud in the Microsoft partnership.

[Mike Gianoni, President and Chief Executive Officer]

JustGiving launch in U.S. is Q1, this Q1. But to Tony’s point, we won’t see expected much revenue this year, but that’s the launch in the U.S.

[Ryan MacDonald, Needham and Co.]

Got it. And just one quick follow-up on, Tony on gross margins. As you continue to this go-to-market partnership with Microsoft and talk about the Azure consumption there. Should we expect to see some additional leverage on that recurring gross margin side as you continue with that migration process?

[Tony Boor]

When you guide to gross margin today, I spoke earlier to some of the pieces that will drive our gross margin potential improvement. So the double-play that we have today moving to the cloud getting out of our cloud data centers, that would be a positive impact on us, we’ve got a little bit of a drag still coming because we are capitalizing, required to capitalize more of our innovation spend from an R&D perspective, and so that amortization will continue to build, which put little pressure on gross margins. But really benefited the day, it comes down to mix.

So our one-time revenue – one-time services has been dropping, that is our lowest margin business, we expect that deceleration to actually increase this year, as we said from of a 17% to 25%. So that should help the prop-up gross margins depending on the mix of the payments business and type of payments, transaction revenue that has lower margin dependent on which, whether that’s large or JustGiving or just our straight payments platform.

So typically we’ll come more so to mix than anything else and we don’t guide at that level, but we’ve been able to do a pretty good job in the last couple of years of holding and slightly improving gross margins. I’d hope that we could continue that for the foreseeable future.

[Mike Gianoni, President and Chief Executive Officer]

Yes. Let me just jump in here to provide some clarification, because your question type – your question was around go-to-market with Microsoft and gross margin. And those two things are not related to us. We have no cost in going to market together with Microsoft. We don’t give additional discounts. We don’t pay fees. It’s our standard pricing and standard discounting. The reason I mentioned earlier that’s very complimentary, because we do not have to pay to go-to-market or provide additional discounting.

Yes the Microsoft field team gets quoted credit because our solutions run on Azure. So those are not connected. So it’s a really great go to market model doesn’t cost us anymore and we can leverage Microsoft’s reach into market and in turn they leverage our reach. The back end of our business, we’re moving from our data centers to Azure, which will improve over time our profitability, because today we have duplicate costs in that regard and we’ll have less of that in the future.

[Operator]

Thank you. We will now take our next question from Mark Schappel of Benchmark. Please go ahead.

[Mark Schappel, Benchmark]

Hi, thank you for taking my question. So just a couple of quick ones here. Tony, was YourCause profitable?

[Tony Boor]

We don’t break out anything on YourCause other than the expectations in the guide that 20 to 25. We expect that it will be dilutive to margins and free cash flow, as I said in the prepared comments. In 2019, I think there’s a little bit of cannibalization potentially on the revenue front. But longer term, we see some really good synergies on both the revenue and the cost structure side. We’ll get that integrated very quickly into the business. And so we see really good long-term opportunity there, but we’ll be dilutive is our expectation to margins and free cash flow in 2019.

[Mike Gianoni, President and Chief Executive Officer]

It’s nicely accretive from an organic growth standpoint, not counted inorganic growth this year, but it’s a fast growing business.

[Mark Schappel, Benchmark]

Okay, thank you.

[Operator]

I would like to turn the conference back over to Mike for any closing comments.

[Mike Gianoni, President and Chief Executive Officer]

Great. Thanks, operator. I’ll just close by saying that I’m pleased with progress we made against our objectives in 2018. We finished the year well. And I’m very excited with our innovation initiatives in TAM expansion. Tony and I look forward to updating you on our progress on the next call. Thanks everyone for your participation.

[Operator]

This concludes today’s call. Thank you for your participation. You may now disconnect.