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Blackbaud, Inc. (NASDAQ:BLKB)

Q4 2009 Earnings Call

February 4, 2010 5:00 pm ET

Executives

Tim Williams - Chief Financial Officer

Marc Chardon - President and Chief Executive Officer

Analysts

Ross MacMillan - Jefferies

Priya Parasuraman - Wells Fargo

Sterling Auty - JPMorgan

Matthew Kempler - Sidoti & Company

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by and welcome to the Blackbaud Fourth Quarter 2009 Earnings Conference Call. I want to note that today’s call is being recorded. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for any questions that you may have.

At this time I would like to turn the conference over to Mr. Tim Williams, Chief Financial Officer of Blackbaud. Please go ahead, sir.

Tim Williams

Thank you, operator. Thank you very much everyone. It is a good afternoon, and we are pleased to have you with us today to review our fourth quarter and full year 2009 results. With me on the call is Marc Chardon, President and Chief Executive Officer. Marc and I have prepared remarks, and then we will open up the call a little bit later for questions.

Please note our remarks today contain forward-looking statements. These statements are based solely on present information and are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Please refer to our SEC filings, including our most recent annual report on Form 10-K, and the risk factors contained therein, as well as our periodic reports under the Securities Act of 1934, for more information on these risks and uncertainties and on limitations that apply to our forward-looking statements.

Also, please note that a webcast of today’s call will be available in the Investor Relations section of our website.

With that, I would like to turn the call over to Marc. And I will come back a little bit later to give some further details regarding our financial performance.

Marc Chardon

Thank you, Tim. And my thanks to all of you on the call today for joining us to review our fourth quarter and full year 2009 financial results. The December quarter was a solid finish to a successful year for Blackbaud, particularly considering that 2009 was the most difficult economic period that the company has faced in its 28 year history. Our fourth quarter revenue and profitability exceeded the high end of our guidance. Moreover, for the full year 2009, we exceeded our non-GAAP operating margin goal. We exceeded our target for new Enterprise CRM customers. And we continue to grow our subscription-based businesses at a solid rate. The business environment remains challenging entering 2010, so we will continue to focus on profitability, investing in our long-term growth initiatives and positioning the company for a return to low-to-mid teens revenue growth, when the economic environment eventually improves.

Let’s take a look at the financial highlights for the fourth quarter. Total non-GAAP revenue of approximately $79.9 million was above the high end of our guidance, up slightly on a sequential basis, and down 2.5% compared to the year ago period. The company’s expense management was strong throughout 2009, and Q4 was no exception. The combination of revenue upside and lower than expected expenses, led fourth quarter non-GAAP operating income that was well above the high end of our guidance. We are proud of the company’s ability to exceed our profit objectives, while at the same time moving ahead with key investments in support of our growth initiatives, including a significant year-over-year increase in R&D spending.

Indeed, it is our investments over the last several years in these growth initiatives that in large part enabled Blackbaud to deliver solid overall financial results in 2009. From a top line perspective, subscriptions remained our highest growth contributor and amounted to more than three times our license revenue. Subscription revenue was $19.3 million and grew at 17% on a year-over-year basis. This is the first quarter since the acquisition of Kintera in which we really had a true apples-to-apples comparison. We are focused on continuing to drive growth from subscription revenue, which is reflected in our product roadmap, which calls for a growing number of products to be made available on a Software as a Service basis.

While it will continue to be our strategy to offer our solutions to customers in the way that they wish to purchase and deploy them, we are seeing increased interest in software offerings sold as a service. We believe we are well-positioned as this trend continues to develop.

Now let me address the current condition of our market. While our financial results exceeded our expectations during the fourth quarter, we are still not at a point that we would call a turn in our target market. There is growing optimism that the economy is stabilizing and may begin to improve during 2010, but we still have not seen a material change in buying behavior at this point.

Looking at our pipeline, the number of opportunities that we are pursuing has increased somewhat when compared to a year ago, but the number of prospects delaying or postponing purchasing decisions has gone up by more than the increase in opportunities. We are pleased, however, that the sales execution of the organization has led to win rates that improved throughout 2009 and we are encouraged that, in spite of the economic challenges, there have been a growth in the number of organizations that have identified a need for increasing their investments in technology.

From a market segment perspective, we continue to see certain segments performing better than others, such as higher education and the Enterprise segment. However, some verticals, such as arts and culture, remain quite challenging. And the low end and mid market segments continue to face greater economic pressures than the higher end. We expect organizations in many sub-sectors of the nonprofit industry to wait for greater certainty of economic recovery before they become more aggressive with investments in technology.

Our experience suggests that the nonprofit industry recovery will lag the overall improvement in the economy, as individuals and corporations wait to see the environment improve before they increase their giving meaningfully and nonprofit organizations, in turn, responding with a willingness to invest. Accordingly, we continue to plan our business based on the assumption that there will not be a meaningful near-term change in the selling environment.

Our focus in 2010 is very similar to that of 2009, deliver modest top line growth, manage expenses closely, invest in our long-term growth initiatives, focus on improving our product positioning and sales strategies, generate strong cash flow, and execute thoughtfully against our capital managing strategies. We are well-positioned to achieve these goals in 2010, as we did in 2009. A significant growth driver for the company has been our Blackbaud Enterprise CRM offering.

During the fourth quarter we closed five Enterprise CRM deals, bringing our full year total to 13, which surpassed our target of closing on average a couple per quarter. On a full year basis our Enterprise CRM-related business represented approximately 18% of the company’s total bookings, which is an impressive achievement, considering that Blackbaud has been in business for over 25 years, and the product became available just over two years ago. The success of our Enterprise CRM offering in a very challenging economic environment is evidence of the strength and differentiation of our solution. It is the right product at the right time for the very largest nonprofit organizations, whose development and information technology teams are forward-looking and willing to move ahead with strategic projects.

During the fourth quarter a couple of those Enterprise CRM deals were in the seven figure range, which has been the sweet spot in this business. At the same time we also saw a couple of deals in the health and human services sector that were between 400 and $800,000 of total deal size. Recall that in our last two earnings calls we mentioned that we were starting to see higher levels of interest among somewhat smaller sized organizations. Also, during the quarter we closed another Target Team Approach conversion deal, our second such deal this year, and the fifth since the initial release of Enterprise CRM.

During the fourth quarter we saw continued solid demand for our subscription-based online fundraising solutions and hosting options as well. Customer response to our relatively new Blackbaud NetCommunity Grow offering continues to be quite favorable. We closed approximately 40 NetCommunity Grow transactions during the fourth quarter. And in only a couple of quarters since the release of this product, we have already signed well over 100 customers. This is an example of our organization’s ability to respond quickly to our customers’ needs and tailor our strategies in the face of a difficult economic environment.

Also, we continued to see solid interest in Blackbaud Sphere, which is our robust feature-rich, stand-alone online fundraising and community building solution. During the fourth quarter we had year-over-year growth in the number of new Blackbaud Sphere units sold, with a sizable portion of the increase coming from deals with variable or transaction-based pricing. While these deals are not likely to have a meaningful near-term impact on our results, they provide upside potential when the economic environment improves and giving begins to reaccelerate. Heading into 2010, we believe that our efforts to bring together the best of Sphere with the best of NetCommunity on our Infinity platforms will be a catalyst for greater long-term growth in this important area of our business.

We continue to believe we are well on our way to consolidating our position as the clear leader and long-term winner in online fundraising for the nonprofit market. Finally, I would like to mention a recent organizational change that we have made, which is designed to set the stage for stronger performance coming out of the economic downturn and over the long-term. We have recently reorganized our business away from the previous functional structure into three largely stand-alone operating units, focused and aligned around key customer groups, the General Markets business unit, the Enterprise Customer business unit, and the International business unit.

We have realized significant success with a high-performance sales team, which focused entirely on Enterprise opportunities. And we believe this next step, which more fully aligns our organization with our customers, will increase our agility as an organization, and allow us to more aggressively address the unique needs of the divergent markets we serve. We also believe the improved customer focus will help us more quickly and effectively bring an expanded number of Software as a Service and on-demand offerings to the marketplace. We will provide more details of this structure over time, but I did want to share with you that we are very excited about what we have seen so far, and believe the new structure will help us to accomplish our long-term goals.

In summary, we are proud of the company’s execution and financial performance in 2009. During the worst economic climate of our lives, Blackbaud had a number of positive achievements. We maintained our overall revenue base, while growing our subscription revenue over 20% on an organic basis. This also served to increase the mix of our business coming from recurring revenue sources. We met and exceeded the goals associated with our strategic initiatives, while we managed overall expenses with world-class execution, leading to almost a 22% non-GAAP operating margin. We generated strong cash flow, which enabled us to pay down $59 million in debt, while also returning $17 million in cash to shareholders via dividends. This is quite unique for a software company of our size.

While we expect the economic environment to remain challenging, we believe Blackbaud’s performance in 2009 is evidence that we have the market position, product portfolio and management team that will enable us to continue delivering solid results. Most importantly, and at some point the economy will improve and we believe that our strategies and the investments we are making today will position us to capitalize on that upturn when it happens. With the economic wind at our back, we expect not only to return to our historic rates of revenue growth, but also realize operating margin improvement to ultimately reach our historic high levels.

Now with that, let me turn it back to Tim.

Tim Williams

Thanks, Marc. Let me begin by providing some further details on our fourth quarter and full year operating results. Then I will follow that with our guidance for the first quarter of 2010, and before wrapping up, obviously, with a quick review of our capital management program.

First let me start with the income statement. As you heard earlier, non-GAAP revenue was $79.9 million for the fourth quarter, which was above our guidance range of 77 to $79 million. This was up slightly on a sequential basis and represented a decrease of 2.5% on a year-over-year basis. We estimate that Q4 revenue would have been down 3% on a constant currency basis. As we commented throughout the year, these year-over-year revenue movements are well below our long-term target of low-to-mid teens growth, which we believe is principally the consequence of the difficult economic environment impacting our end markets. Our long-term target of low-to-mid teens growth remains our goal in a healthier economic environment.

Looking at the details of our non-GAAP revenue, subscription revenue was 19.3 million, an increase of 17% on a year-over-year basis. It increased to 24% of our total revenue in the fourth quarter, up from 20% in the year ago period. License revenue was 6.3 million in the fourth quarter, compared to 8.6 million in the year ago quarter. The decline in license revenue is principally a result of the fact that the majority of our license revenue has been generated from the mid market segment of our business, which has been more heavily impacted by general economic weakness. In addition, as we have previously indicated, we are selling more of our solutions on a subscription basis.

Our non-GAAP services revenue came in at 22.2 million, a decrease of 15% on a year-over-year basis, and 4% sequentially. As a reminder, our service revenue is typically down sequentially in the fourth quarter and this year’s sequential decline was actually somewhat less in both absolute dollars and percentage terms than what we’ve had experienced in the past couple of years. The year-over-year decline in services revenue is a natural derivative of the decline in license revenue I mentioned a moment ago. Our maintenance revenue represented the largest source of revenue during the quarter and it came in at 29.9 million, an increase of 6% on a year-over-year basis, and up modestly sequentially. Our maintenance renewal rates continue to be in the mid 90% range, despite the tough economic conditions.

Turning to profitability and to be clear here, all non-GAAP expense and profitability percentages that I will refer to, are based on the non-GAAP revenue amounts. So starting with gross profit, we generated 52.5 million of non-GAAP gross profit in the quarter, representing a gross margin of 66%, which was up from 65% last quarter and 64% in the year ago quarter. This is being driven by the increasing scale we are getting from the infrastructure supporting our hosting and SaaS offerings. The combination of better than expected revenue and continued solid cost management led to non-GAAP operating income of $19.2 million, which was well above the high end of our guidance range of $16.5 million to $17.5 million, and represented a non-GAAP operating margin of 24.1%. The effective tax rate for non-GAAP results in the quarter was again 39%, leading to non-GAAP diluted earnings per share of $0.27, which was also above the high end of our guidance range of 23 to $0.24.

As a reminder, we fully tax non-GAAP EPS amounts, even though the company’s cash tax rate is much lower, due to our deferred tax assets and other tax benefits associated with recent business acquisitions. In our earnings release there is a full tabular reconciliation between our non-GAAP and GAAP results, which include the deferred revenue add back from Kintera, and the impact of stock-based compensation expense, and the amortization of intangibles associated with acquisitions. In summary fourth quarter GAAP revenue including a $900,000 purchase accounting adjustment related to Kintera’s revenue was $79 million, GAAP operating income was 13.3 million, net income was eight million and GAAP diluted earnings per share was $0.18. This compared to GAAP diluted earnings per share of $0.15 in the same period last year.

I would now like to provide a very brief summary view of our 2009 results. Total non-GAAP revenue was $312.8 million for the year, an increase of 2% compared with 2008. On an organic basis, revenue declined 4.5% and on a constant currency basis 3%. From a profitability perspective, full year non-GAAP income from operations was 68.6 million, representing a non-GAAP operating margin of approximately 22%, which was approximately 200 basis points better than the original goal we shared with you at the beginning of 2009. The primary driver of our ability to exceed our profitability goal was the identification of approximately $21 million in cost savings during the year.

We think this is an impressive accomplishment, especially when you consider that these savings were achieved while we were also significantly increasing our investment in R&D by approximately $7 million year-over-year. Non-GAAP net income for all of 2009 was 41.8 million, leading to non-GAAP diluted earnings per share of $0.96. This compared to non-GAAP net income of 41.7 million and diluted earnings per share of $0.95 in the full year 2008. Looking then at the full year profitability on a GAAP basis, net income was 28.4 million or $0.65 per share, compared with 29.9 million or $0.68 per share in 2008.

Let me now turn to cash flow and the balance sheet. We ended the fourth quarter with $22.8 million in cash, up just over 500,000 from the end of Q3. Cash flow from operations was 26.4 million in the fourth quarter and 86.8 million for the full year 2009. Accounts receivable dropped this quarter to 50.2 million from 51.3 million at the end of the prior quarter, leading to a DSO at the end of the quarter in the mid-40s, which is consistent with our historical performance.

During the fourth quarter we paid down the remaining 17.5 million of outstanding debt that existed under our line of credit facility. This completed slightly ahead of our original plans the repayment of over $60 million in debt, drawn in 2007 and 2008, to support our M&A activity. Our enhanced balance sheet along with a strong cash flow generating capability, gives us significant financial flexibility as we enter 2010. Total deferred revenue came in at 135.6 million, which was up 15.9 million or 13.3% on a year-over-year basis.

The strong growth in deferred revenue on an annual basis is the result of continued strength in our maintenance renewals, combined along with solid sales momentum related to our subscription-based products and services. Finally, at the end of the quarter the company’s deferred tax asset had a balance of 61.3 million. As a reminder, this asset adds roughly $8 million to our cash flow on an annual basis, in addition to an annual cash flow benefit of approximately $3.5 million associated with the structure applied to our three most recent acquisitions.

Turning now to guidance, our guidance for the first quarter, we are targeting non-GAAP revenue of 75 to 77 million, with non-GAAP operating income of approximately 13.5 to 14.5 million, leading to non-GAAP earnings per share of $0.19 to $0.20. Our plan is to continue focusing on quarterly guidance, at least as we start the year. That said, Marc, shared several points related to how we are planning our business for 2010. We are focused on several goals, including delivering at least low single-digit revenue growth, and continuing to manage our expenses very closely.

With regard to the first goal, we believe this can be accomplished with sales or bookings that are essentially flat with 2009. As it relates to our second goal, we implemented several actions during 2009 that we think should have a positive impact on our 2010 cost structure. These should enable us to continue investing in key growth opportunities. If we can achieve the low single-digit revenue growth, we would hope to expand our non-GAAP EBIT margin by a few 10s of basis points. If we were able to generate higher growth, we would hope to improve margins in the range of 100 basis points. At such point in time as there is greater visibility into the pace of economic recovery, we would expect to provide greater granularity into our business outlook beyond the next quarter.

Finally, I would like to finish with a very quick update on our two-part capital management program. First, as I am sure you have all seen, we announced today that our Board of Directors has declared our first quarter dividend of $0.11 per share. This is $0.01 higher than the per share level that we were paying in 2009. The first quarter dividend is payable on March 15, 2010 to stockholders of record on February 26, 2010. Second, we do not make any share purchases during the quarter. We still have approximately $30 million of capacity remaining in our $40 million share repurchase program. And we will continue to balance the best ways to use our cash flow to enhance long-term shareholder value.

In summary, we continue to be pleased with the company’s execution and ability to deliver solid financial results in the face of a very difficult economic environment. We exceeded our quarterly revenue targets in each quarter during 2009, and we have exceeded our full year profitability objectives based on solid expense management. We are not calling for a turn in the market environment, but we are confident of the company’s ability to continue executing at a higher level.

With that, let me turn it over to the operator and we’d be happy to take your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And we’ll go first to Ross MacMillan from Jefferies.

Ross MacMillan - Jefferies

Tim, sorry, could you just go back and describe the relationship that you gave regarding, I think it was bookings and the low single-digit revenue growth for calendar ‘10. Did you say if bookings are flat that would allow you to achieve that low single-digit?

Tim Williams

That is exactly what I was trying to communicate.

Ross MacMillan - Jefferies

Perfect. Great. Thanks. And then just on the add back from the Kintera acquisition, that was higher sequentially than last quarter. And my experience is as you basically have these deferred revenue add backs they usually taper off kind of linearly. Could you just help me understand that? Thank you.

Tim Williams

Sure, sure. It’s a great question. During the quarter we actually had a one-time services revenue pickup of about $0.5 million. That was not built into our estimates as we went into the quarter. What that relates to is to a Kintera project that had this balance deferred at the time of acquisition, and could not be recognized because there was an additional deliverable that was required. For GAAP purposes we couldn’t record that deferred revenue, but it had never been recognized. We completed that deliverable in the fourth quarter. As we went into the quarter we weren’t sure that was going to be the case, but we did make that delivery, and that’s what triggered the big increase.

Ross MacMillan - Jefferies

And just to be clear, is all the residual gone now, or could we still see any more come through? And is there any deferred to add back on a go forward basis, or that is all done?

Tim Williams

Nothing like this. There is still a relatively small residual that carries over into 2010, Ross. But I think, as maybe I have explained before, it would not be our intention to continue to report non-GAAP revenue. The amounts are very small.

Ross MacMillan - Jefferies

Yes. And then you obviously did a great job in 2009 on the costs side, without having really to make any head count changes. How do we think about costs in 2010? And specifically when you managed to moderate cost growth so well in 2009, is there any suppressed costs that has to flow back and is that in your guidance? Thanks.

Tim Williams

I would say that that the only thing that could be factored in – or that was suppressed, we do have some promotional increases associated with people that have been promoted into new assignments. Those took effect at the beginning of the year. There will be most likely salary adjustments also as we move into the second quarter. But that’s baked into our thinking about the first quarter. And baked also into the broad comments I made about the full year.

Ross MacMillan - Jefferies

And then a very last one, just a product question, if I could. You may have mentioned, I missed the early part of the call, but could you just recap on the RE 8 timeline, what we should expect to see in calendar ‘10? Thanks a lot.

Marc Chardon

Yes. Thank you, Ross. In calendar ‘10 you’ll see the end of the early adopter programs for the arts and cultural solution, which is the first generation 8 solution for the general market. You will see the first versions of the general Raiser’s Edge offering in the second half of the calendar year as well. It will be a SaaS only model, and it will primarily be for new customers, as opposed to an upgrade version. Obviously, you’ll continue to see Version 8 products of the eCRM, the Enterprise CRM versions continue to come out. We just released Version 2.5 at the end of last month. And you’ll see Infinity-based versions of the merged Blackbaud Sphere and NetCommunity roadmap.

Operator

And from Wells Fargo Securities, Phil Rueppel.

Priya Parasuraman - Wells Fargo

Thanks. This is actually Priya Parasuraman. How are you? So I was wondering do you have any new products in your revenue guidance for 2010 in your model.

Marc Chardon

Well, the only new product is the one that I described, which I would call the arts and cultural solution, that’s new to the portfolio or addresses probably in the sort of an incremental market segment, it addresses arts and cultural customers that might reach a little further down into the size range for arts and cultural customers. That would be the only thing that I would characterize as new. The others are continuing or expansions of existing product offerings.

Priya Parasuraman - Wells Fargo

Okay. And could you talk about your eCRM pipeline for 2010, and whether, similar to ‘09, you expect two deals per quarter for that?

Marc Chardon

Repeat the last half of that, please, I’m having a hard time hearing.

Priya Parasuraman - Wells Fargo

Talk about your eCRM pipeline for 2010.

Marc Chardon

Yes. Sure.

Priya Parasuraman - Wells Fargo

And do you expect two deals per quarter, similar to last year?

Tim Williams

Well, yes. The eCRM pipeline remains quite strong. We have a lot of interest, so I am again quite optimistic. I think that the goal of a couple deals a quarter is quite reasonable. Until I see a turn in the market, I’m not going to go on record saying we’ll have a lot more units, but there can be sort of an increase in the number of units based on some of the smaller deals that I was talking about as well. So I’d like to see us do about sort of the same as we did this year, a couple a quarter, maybe a little bit better. And the pipeline is definitely there to allow us to have that ambition.

Priya Parasuraman - Wells Fargo

And the online business, how is competition there? Could you talk a little bit more about that?

Marc Chardon

Well, we’ve been doing pretty well based on our overall competitive position. We sold a lot of units this year. And I’m quite confident that we’re taking market share compared to the overall market opportunity. So the demand remains strong. We have a large installed base of people who use our CRM products, whether The Raiser’s Edge or eCRM now or Team Approach. And more and more of them are looking for a very high level of integration between the two products, because they know that the combination of online and offline fundraising and the ability to know all of your interactions with the constituent gives you a competitive edge in raising money. So the interest is growing, the momentum is growing. I just wish that budgets were growing as fast as interest.

Operator

And from JPMorgan, Sterling Auty.

Sterling Auty - JPMorgan

So just on the high level, on the economic outlook and the caution that’s still there, when you talk to the customers, how concerned are you that the economic kind of downturn and overhang that we’ve got is going to spill into the budgets on a lot of these not-for-profits that have June 30 fiscal year end?

Tim Williams

I’m quite confident that the downturn will continue to influence the budgets that will be made on June 30 for next fiscal year starting in July. So I’m very confident that they will be quite cautious at this point in time. I can’t imagine this improving significantly between now and then.

Sterling Auty - JPMorgan

And as you look back in terms of your history, and maybe even discussions with customers, as they look back, is there any precedent where if we start to see a healthier economy, let’s say late in the year, that they would actually come back and revisit those budgets and change some of their capital improvement funds and some of the programs that they would use to possibly take on more of your solution set?

Marc Chardon

Well, first, I don’t believe there’s any real precedent, Sterling. You take a look at this, the economy is more difficult than any that I’ve seen during the 28 years of this company or during the 40 or so years for which there’s data on giving contributions. What I can tell you is that, just as the contributions sort of were more sustained at the beginning of the downturn than people might have expected, I expect that there’ll be a lag in terms of contributions turning back up, even once you’ve seen employment turn up, which we haven’t yet seen. So it would surprise me a fair amount if there were a dramatic improvement in sort of budgets for these organizations throughout the year.

That said, there are sectors and pockets of our business where people think of investing capital as a way of dealing with the lack of fundraising opportunities. And we’ve seen some modest movement in that direction in terms of sort of some of the middle-sized accounts, which had been being hesitant. When we do polling and telephone calls, which we do, you know, over half of the no decisions are telling us that they believe that they’ll be back in market within 18 months. So I believe, there is a reason for cautious optimism, but not short-term optimism.

Sterling Auty - JPMorgan

Got you. And Tim, as you look at the gross margins in the quarter, I don’t have all the detail right in front of me, but it seems like it was much better than what we expected. Was there anything from either a mix perspective or better utilization in professional services, or was there something that you felt that provided the real good result here in gross margins?

Tim Williams

Well, I think that there are a couple keys. I think, the most important one to me is I think you’re starting to see, particularly in the subscription line, the impact of scale that we’re getting in some of the actions that we’ve taken. To just cite one example, Marc has talked a couple times in previous calls about some work we’ve done with data center consolidation. We’re starting to realize some of those benefits, and if you look at that subscriptions margin, that’s a good part of where the improvement is coming. Another area was, if you just look at services, our decline in services revenue sequentially, as I mentioned on the call, wasn’t quite as large as it has been in prior quarters. There are a variety of reasons for that. But in general that helped us, I think, a little bit on the gross margin line certainly.

Sterling Auty - JPMorgan

Okay. And then last question is, as we think about it, you talked about the low single digit growth in revenue, a little bit of margin expansion. Taking that as a baseline, how should we think about cash flow for this coming year? Was there anything that you would see non-recurring that benefited 2009 that doesn’t repeat in 2010, or should we just have with that increase in revenue, a little bit of margin expansion providing that type of growth to cash flow?

Marc Chardon

Well, I think, from a cash flow standpoint, as always, I think you have to kind of start with your view about where you feel non-GAAP earnings are going to come out. As we’ve always said before, our non-GAAP earnings, the cash flow from ops will be higher than that for a couple reasons, large maintenance and subscription revenue base, and the benefit that we get from the cash upfront versus how the revenue is being recognized. And then, of course, the deferred tax assets.

But I would be very cautious about not building off of, or trying to build off of the $87 million of cash flow from operations that we had in 2009. We are excited about that performance, but there were a couple of nonrecurring items in there. The most significant of which have to do with some tax benefits that we were able to achieve. We actually went back and filed for and sought some additional credits related to R&D expenditures. We went back and also did some work in some other areas of tax credits. Actually we covered some refunds, and did not have to pay any deposits during the year. So in addition to all the other tax stuff that is recurring, we did get some special benefits there.

And in addition, we got a little bit of a bump in receivables. As you recall in 2008, we had some buildup in receivables that we brought down through the year. The buildup occurred because of the conversion to a new accounting system. A little bit of that carried over into 2009. But that’s why I say, I think if you take some of those one-time items out, you would get a number that probably from a cash flow from operations standpoint would be more like, kind of like 75 million as opposed to the 87 that you got here, or 75, 74, 73, something in that range.

Operator

(Operator Instructions). And from Sidoti & Company, Matthew Kempler.

Matthew Kempler - Sidoti & Company

So a couple of things here. First on the reorganization that you mentioned away from the functional structures, does that entail any changes in head count or is it more specifically just realignment of the existing staff?

Tim Williams

There was no change in head count associated with the business unit realignment.

Matthew Kempler - Sidoti & Company

Okay. And can you give us an idea of where we ended the year in terms of quota account sales reps? And -

Tim Williams

Yes. With quota carrying reps, we were at roughly 230, 233, somewhere in that range. That was down about 20 quota carrying reps since the beginning of the year.

Matthew Kempler - Sidoti & Company

Okay. And do you feel you have the team you need at this point to execute on the new structure or are you looking to hire throughout the year?

Marc Chardon

I think that we’ll probably be pretty flat in head count throughout the year. And specifically, I think, we’re feeling pretty confident that the sales organization has enough quota carrying capacity.

Matthew Kempler - Sidoti & Company

Okay. All right. I wanted to ask you on the gross margin, you mentioned the scale on the recurring revenue streams that you’re starting to see, but it looks like the costs actually came down sequentially on both the maintenance and the subscription lines. And I just wanted to understand if there were any specific actions there that help bring those costs down?

Tim Williams

Well, one of the things we did in the third quarter, given how we were performing against our budgets from a cost standpoint, we did go back and do one-time bonus payments to people below the management level. And you’ll recall that the individuals within the organization, nobody got a salary adjustment. So we felt, given how the performance was taking place here, we felt a one-time payment to the people below the management level of one-time bonuses, and those bonuses affect several lines within the individual income statement at the cost of revenue line.

Matthew Kempler - Sidoti & Company

Okay. Understood.

Tim Williams

And we obviously didn’t have that recur in the fourth quarter.

Matthew Kempler - Sidoti & Company

Right. Okay. And then regarding eCRM, you mentioned that it was about 18% of bookings for all of 2009, correct?

Tim Williams

That’s correct.

Matthew Kempler - Sidoti & Company

Okay. And I know in the third quarter the commentary was that it was about 5% of revenue. Are we starting to see that creep up again in the fourth quarter, and is the expectation even higher in the first quarter, or is the revenue recognition still being deferred on that primarily?

Tim Williams

Well, as has been the case in several quarters this year, we have had some situations where we have had some revenue recognition upfront for the license component. Of the five deals we did, we had two of them where we did have that this quarter. And of course, we had the deferred recognition on the rest. I don’t remember the exact number, but I doubt that it didn’t change much from what we saw in the third quarter on an overall basis, Matthew.

Matthew Kempler - Sidoti & Company

No.

Tim Williams

It could be a tad bit higher, but I wouldn’t expect it to be dramatically different.

Matthew Kempler - Sidoti & Company

Okay. And then the final thing from me is on the Sphere product. Can you talk about what’s driving the shift to the type of model now where you’re looking to recognize revenue more on a transactional or variable basis versus the traditional subscription?

Marc Chardon

Well, I think that every organization, especially if the customers of ours, who have traditionally the kind of customers that might have bought The Raiser’s Edge, are looking to, in this economic environment sort of variabilize or share the risk. And one way of doing that is by not having an upfront license fee. And a second way of doing that is having a portion, some or all of the revenues they pay be based on the transactions of the success of the fund-raising associated with that fund line system. Market demand.

Matthew Kempler - Sidoti & Company

Okay. So the expectation here though this would help accelerate, I guess, penetration of the product then?

Marc Chardon

It clearly is a factor in getting the win rates that we’ve had and improving versus online competitors, as well as bringing the no decision rate down modestly, bringing people who would have otherwise made no decision for financial reasons back into the market. Yes.

Operator

And we’ll take a follow-up question from Sterling.

Marc Chardon

Hey, Sterling.

Sterling Auty - JPMorgan

So on the organizational shift, going to the new structure that you’re talking about, how deep are you going to carry the support in each one of the enterprise versus the other couple segments? Meaning, I get the dedicated sales, but are you going to have dedicated R&D staff, Q&A, marketing? What are going to be the things that are going to be in each one of those silos?

Marc Chardon

What we did was to put anything that basically is pretty much gross margin producing in the business units. So the customer support is there. The professional services are there. The training is there -- the convergence services, the analytics business. Pretty much anything that is sold to the customer, and then delivered by us one way or another, other than product development is there. And product development does however have the data centers, because the connection between engineering and the efficiency of your data center is probably a higher value than sort of having a business unit run across the new data center. So pretty much anything that wasn’t product development and then the product management necessary to deliver it, and the data center was moved into the business unit.

Sterling Auty - JPMorgan

Okay. I’m going to play devil’s advocate here. So looking back over the years I watched Adobe and several other high-profile companies kind of go in this direction, and then go back to the functional area. When you looked at it, is there something that you felt that you were going to do differently or really gave you an advantage to leverage this model to better your execution rather than some of the difficulties we’ve seen other software companies have with it?

Marc Chardon

The other software companies are typically quite a bit larger and/or have a narrower customer base. We go from two-person non-profits, who spend $100 a year with us or $29.95 a month to people willing to spend mid-seven figures. And what we’re finding is that the offering that they want and the solution that they want and the professional services that’s required to deliver it and so on, are really quite different. I mean, it’s sort of like saying should Intuit and SAP have the same business model. And I’m pretty sure that if you had Intuit and SAP in the same company, you’d probably have two divisions.

Operator

And gentlemen, there are no further questions at this time. I’ll turn the conference back over to you for any additional or closing comments.

Tim Williams

We don’t have any further comments to offer up at this time. We thank everybody for joining us. We thank everyone for their support during the year. And if there are follow-up questions, please feel free to give us a call. Marc and I will be on the West Coast next week visiting with investors. We look forward to seeing some of you on the road then. Thank you very much.

Marc Chardon

Thanks a lot. Bye-bye now.

Operator

Ladies and gentlemen, that does conclude today’s conference. We thank you for your participation.

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Source: Blackbaud, Inc. Q4 2009 Earnings Call Transcript
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