BLACKBAUD INC quarterly report, Q2 FY2023

Blackbaud, Inc. — Q2 2023 Form 10-Q

Business context and period: Blackbaud provides cloud software, payments and related services focused on nonprofits, education and corporate social impact. This unaudited filing covers the quarter and six months ended June 30, 2023; comparisons are with the corresponding 2022 periods. The company reports one operating segment.

Financial performance and position

Metric	Q2 2023	Q2 2022	Six months 2023	Six months 2022
Revenue	$271.0m	$264.9m	$532.8m	$522.1m
Gross profit / margin	$149.6m / 55.2%	$139.3m / 52.6%	$288.2m / 54.1%	$273.1m / 52.3%
Operating income (loss) / margin	$0.3m / 0.1%	$0.1m / approximately 0%	$(9.7)m / (1.8)%	$(5.9)m / (1.1)%
Net income (loss)	$2.1m	$(3.4)m	$(12.6)m	$(13.8)m
Diluted EPS	$0.04	$(0.07)	$(0.24)	$(0.27)

• Q2 recurring revenue rose 3.9%; one-time services and other revenue fell 30.3%. For the first half, recurring revenue grew 3.6% while one-time revenue declined 29.0%.
• Q2 GAAP results included a $10.2m income tax benefit; the effective tax rate was 126.0%, affected by nondeductible Security Incident accruals. The benefit contributed to reported quarterly net income despite a pretax loss of $8.1m.
• First-half operating cash flow was $75.0m, down 8.3%. Capitalized software and content development costs were $28.8m and property and equipment purchases were $2.8m. Free cash flow, as defined by the company, was $43.5m; adjusted free cash flow was $59.3m after adding back $15.8m of Security Incident-related cash outflows.
• At June 30, cash and cash equivalents were $29.0m; restricted cash was $761.3m, principally customer funds, and should not be treated as freely available company liquidity. Total debt carrying value was approximately $846.6m. Net leverage was 2.67x; the company reported $325.8m of available capacity under its credit facility and compliance with covenants.
• Working capital was negative $316.6m. Current liabilities include amounts due to customers and deferred revenue; customer-related restricted cash substantially offsets customer-fund obligations and is not ordinary corporate cash.
• Deferred revenue was $438.2m, up 13.7% from year-end, primarily reflecting seasonal customer renewals. Remaining performance obligations were approximately $1.2bn, with about 50% expected to be recognized over the next 12 months.

Material changes versus prior periods

• Revenue growth was modest, led by transactional recurring revenue—particularly Tuition Management and JustGiving—and cloud performance and pricing initiatives. Foreign exchange reduced first-half revenue by $3.7m, according to management’s estimate.
• Gross margin improved, while first-half operating loss widened. General and administrative expense rose $20.8m for the half, principally because Security Incident-related expense increased by $29.0m year over year.
• First-half GAAP net loss improved by $1.2m, but operating cash flow declined $6.8m. Financing cash flows improved substantially versus 2022, partly because the change in restricted customer funds was a $61.3m inflow versus a $141.0m outflow in the prior-year period.
• Non-GAAP measures showed Q2 operating income of $74.1m, a 27.4% margin, and adjusted EBITDA of $88.8m, a 32.8% margin. These measures exclude specified costs, including Security Incident expenses, and are not substitutes for GAAP results.

Outlook, commentary and risks

• Management expects revenue growth to accelerate in the second half of 2023 as pricing initiatives take effect, and expects profitability to improve sequentially. It expects one-time services revenue to continue to decline as the business shifts toward cloud subscriptions. These are management expectations, not guarantees.
• Management expects 2023 interest expense of approximately $37m–$41m. Variable-rate debt remains exposed to rising rates, although interest-rate swaps hedge portions of exposure.
• For 2023, management estimates $20m–$30m of net pretax expense and $25m–$35m of net cash outlays for ongoing Security Incident legal fees. These estimates exclude prior settlements and recorded loss-contingency accruals.
• The May 2020 ransomware incident remains a major contingency. The company recorded approximately $50m in aggregate liabilities for loss contingencies, but says additional losses could materially exceed accruals and cannot currently be estimated. It faces customer claims, 19 putative consumer class actions and ongoing governmental investigations. The SEC matter was settled in March 2023 with a $3m civil penalty, without admitting or denying the order’s findings.
• Insurance coverage for the incident has been exhausted. First-half 2023 net pretax incident expense was $44.6m, including $30.0m of additional loss-contingency accruals; management says the matter will continue to affect GAAP results and cash flow.
• After quarter-end, a sublease for part of the closed Washington, DC office led management to expect $6m–$8m of noncash impairment charges in Q3 2023.
• Other considerations include $270.4m of remaining minimum purchase commitments through 2027, approximately $123m of estimated future debt interest payments, and debt maturities under the credit facility in October 2025. Management believes available liquidity and anticipated operating cash flows are adequate for at least 12 months and targets reducing net leverage to 2.0x.
• Management reported gross dollar retention of approximately 90% for the 12 months ended June 30, 2023, broadly consistent with 2022. It also identified cybersecurity, customer retention, foreign exchange and interest rates as ongoing risks.

Important facts for investors to verify

• Whether pricing and multi-year renewals deliver the expected growth and retention benefits, and how much reported growth depends on transactional revenue.
• The timing and ultimate cost of Security Incident claims and investigations, including potential losses beyond the $50m accrued and the stated 2023 legal-fee estimates.
• Cash generation after capitalized development spending and incident-related payments; distinguish unrestricted cash from restricted customer funds.
• Debt repayment, interest expense, covenant headroom and progress toward the 2.0x net-leverage target.
• Whether the expected Q3 office impairment remains within the $6m–$8m estimate and whether other costs or contingencies emerge.
• The basis and exclusions in non-GAAP results and adjusted free cash flow when comparing performance across periods or with other companies.