Blackbaud, Inc. — Q3 2018 Form 10-Q
Business context and period. Blackbaud provides cloud software, services, payment processing and data solutions to nonprofits and other social-good organizations; it reported more than 40,000 customers. This unaudited filing covers the quarter and nine months ended September 30, 2018, compared with the same 2017 periods. The company reports as one operating segment.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $209.5M | $194.4M | $627.4M | $571.1M |
| Recurring revenue | $188.7M | $167.5M | $562.3M | $493.9M |
| One-time services and other revenue | $20.9M | $26.9M | $65.1M | $77.1M |
| Gross profit / margin | $114.3M / 54.5% | $107.4M / 55.2% | $348.9M / 55.6% | $311.6M / 54.6% |
| Operating income / margin | $15.8M / 7.5% | $18.4M / 9.5% | $44.7M / 7.1% | $48.2M / 8.4% |
| Net income | $11.2M | $12.8M | $35.5M | $37.0M |
| Diluted EPS | $0.23 | $0.27 | $0.74 | $0.78 |
Q3 revenue rose 7.8%, while recurring revenue increased 12.6%; one-time services and other revenue fell 22.4%. For the nine months, revenue grew 9.9% and recurring revenue 13.8%, while one-time revenue declined 15.6%. Management attributed growth chiefly to cloud subscriptions and, in part, to the JustGiving and Reeher acquisitions. Non-GAAP organic revenue growth was 1.2% in Q3 and 3.7% for the nine months; organic recurring revenue growth was 4.9% and 6.7%, respectively.
Recurring gross margin was 59.4% in Q3 versus 60.2% a year earlier, reflecting higher data-center and software amortization costs. One-time services gross margin contracted to 10.4% from 24.7%, as higher-margin analytics and license revenue declined. GAAP operating income fell 14.3% in Q3 and 7.2% for the nine months; increased sales and product investment, acquisition-related amortization, stock compensation and restructuring contributed. Non-GAAP diluted EPS was $0.59 for Q3 and $1.94 for the nine months, versus $0.57 and $1.60, respectively; these adjusted measures exclude specified items and are not GAAP results.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $137.8M, up from $123.4M. Non-GAAP free cash flow, defined as operating cash flow less property purchases and capitalized software development, was $98.3M, versus $94.4M.
- Investing cash outflow was $84.9M, including $45.3M for acquisitions, $26.6M of capitalized software development and $12.9M of property and equipment. Financing cash outflow was $487.8M, heavily affected by a $425.2M decrease in amounts due to customers and related customer-restricted funds.
- At September 30, cash and cash equivalents were $25.4M; restricted cash due to customers was $179.7M, with a corresponding $185.2M due-to-customers liability. Working capital was negative $191.2M; movements in customer funds significantly affect these balances.
- Gross debt was $427.0M; debt carrying value under the credit facility was approximately $424.2M. The company had $260.6M of available borrowing capacity and a 2.02x net leverage ratio, within the 3.50x covenant limit. The credit facility matures in June 2022, when most principal is scheduled to come due.
- Management said available funds and expected operating cash flows should cover operations, capital expenditures, debt obligations and dividends for at least the next 12 months. Quarterly dividends were $0.12 per share; the board declared the same amount for Q4, but future dividends are not guaranteed.
Changes, outlook and notable items
- Blackbaud continued its shift from on-premises products and one-time services toward cloud subscriptions. Management expects one-time services revenue and related margins to remain under pressure during the transition; maintenance revenue also declined as customers migrate to cloud offerings.
- Customer retention for recurring-revenue customers was approximately 92% for the 12 months ended September 30, a modest decrease from the prior full-year rate. Management linked the decline partly to rationalizing legacy products and migrating customers to newer cloud solutions.
- Sales-force hiring and product development investment were expected to continue into Q4 2018 and beyond, with management targeting revenue-growth benefits in late 2019 and more fully in 2020. The filing provides no specific numerical full-year revenue or earnings guidance.
- New product initiatives included cloud solutions for faith communities and higher education, and a jointly developed nonprofit initiative with Microsoft. Blackbaud Church Management was expected to be generally released in mid-2019; the first Nonprofit Resource Management capability was expected in summer 2019.
- Reeher was acquired in April for approximately $41.3M in cash to expand fundraising performance management. Its preliminary purchase accounting included $27.1M of identifiable intangibles and $13.8M of goodwill. Management said the acquisition was not material to consolidated results.
- A multi-year office-consolidation plan had incurred $4.4M of cumulative restructuring costs by September 30. Expected total pretax costs were $6M–$8M, with most remaining costs by end-2019; management projected annual pretax savings of $3M–$4M beginning in 2020. Potential severance costs were not reasonably estimable.
- The nine-month effective tax rate was negative 7.2%, primarily due to stock-compensation tax benefits, the lower U.S. federal tax rate and release of a tax reserve. This unusually favorable tax result supported reported net income and may not recur at the same level.
- Remaining performance obligations were approximately $715M; about 60% was expected to be recognized over the next 12 months. The company adopted the new revenue standard retrospectively in 2018; it also expected the new lease standard to put most lease commitments on the balance sheet upon adoption in 2019.
Risks and items to verify
- Whether recurring and organic growth can accelerate as legacy maintenance and one-time services continue to decline, and whether retention stabilizes above or near 92%.
- Whether sales, product-development and infrastructure spending translates into the growth and margin improvement management expects; Q3 GAAP operating margin declined to 7.5%.
- Debt repayment and refinancing capacity, particularly the large 2022 maturity, interest-rate exposure and continued compliance with credit-facility covenants.
- Cash-flow interpretation: restricted customer funds and amounts due to customers drive large financing-cash-flow movements and should not be confused with unrestricted liquidity.
- Execution and final purchase accounting for Reeher, delivery and adoption of announced products, and achievement of restructuring savings; acquisition valuations and some acquired balances remained preliminary.
- Potential legal outcomes, foreign-currency changes, customer renewal demand, and uncertain tax positions. The filing reported no material change to previously disclosed risk factors and no material off-balance-sheet arrangements.