Blackboard Q4 2006 Earnings Call Transcript

Feb. 6.07 | About: Blackboard Inc. (BBBB)
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Blackboard Inc. (NASDAQ:BBBB)

Q4 2006 Earnings Call

February 6, 2007 4:30 pm ET

Executives

Michael Stanton - VP, IR

Michael Chasen - President and CEO

Michael Beach - CFO

Matthew Small - Chief Legal Counsel

Analysts

Kirsten Edwards - ThinkEquity Partners

Ariel Schochet - Wedbush Morgan Securities

Kash Rangan - Merrill Lynch

Amy Junker - Robert Baird

Howard Block - Banc of America Securities

Trace Urdan - Signal Hill

Brandon Dobell - Credit Suisse

Tom Roderick - Thomas Weisel Partners

Richard Baldry - First Albany Capital

Presentation

Operator

Good day ladies and gentlemen and welcome to the fourth quarter 2006 Blackboard Earnings Call. My name is Lisa and I'll be your coordinator for today. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to Mr. Michael Stanton, Vice President and Investor Relations. Please proceed Sir.

Michael Stanton

Thanks Lisa. Hello and thank you for joining us today for Blackboard's fourth quarter and yearend conference call. As usual, I would like to remind everyone that except for historical information presented, the matters discussed today may contain forward-looking statements under the Safe Harbor Provision of the Private Securities Litigation 1reform Act of 1995. Such statements are based on management's current expectations and are subject to a number of risks and uncertainties that could cause actual performance and results to differ materially from those discussed in the forward-looking statements. Among the important factors that could cause actual results to differ materially from those indicated by such forward-looking statements, are delays in product development, undetected software errors, competitive pressures, our ability to effectively integrate WebCT's operations with our own, technical difficulties, market acceptance, availability of technical personnel, changes in client requirements, risks of international operations, general economic conditions and such other risks as described in the 'Risk Factor' section of Blackboard's most recent Form-10Q on file with the SEC. Blackboard undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions the occurrence of unanticipated events or changes in future operating results.

A few administrative notes related to some of the metrics we will provide today. We will provide non-GAAP cash net income, non-GAAP cash net income, non-GAAP adjusted net income and non-GAAP adjusted net income per share on this call as additional information regarding our operating results. The measures are not in accordance with, nor an alternative for GAAP and maybe different from other non-GAAP measures used by other companies.

Blackboard believes that the presentation of these financial measures provide useful information to investors regarding additional financial and business trends, relating to the company's financial condition and results of operations.

A reconciliation of GAAP and non-GAAP metrics has been provided in today's earnings press release which is available on our website.

Secondly, today we will provide contract value. Our contract value represents the annualized recurring ratable revenue under existing contracts with clients in effect at the end of the quarter, without regard to the remaining duration or renewal of such agreements. This is not intended by management for the estimation of or as a proxy for future revenue to be recognized, but management believes it is a useful tool for investors to evaluate our current operating performance.

Finally, we have once again provided some supplemental information related to clients, licenses, contract value and headcount on the 'Investor Center' section of our website at investor.blackboard.com. The document in question is titled Blackboard 2006 Operating Metrics.

On today's call are Michael Chasen, President and CEO and Michael Beach, our Chief Financial Officer. At this time, I'm going to turn the call over to Michael Chasen. Michael.

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Michael Chasen

Thanks, Michael. Good afternoon everyone. Let me start with an overview of the agenda for today's call. First, I will give you a summary of our performance for the quarter ended December 31, 2006. We will cover the major contributors to our business performance in the quarter and year and then I will provide some comments on our operational priorities in 2007. I will then turn the call over to Michael Beach, our CFO, to take us through a more detailed review of the financials and guidance. And finally we will close with your questions at the end of the call.

We had another excellent quarter and a terrific year in 2006. Among the highlights, in the fourth quarter we increased revenues year-over-year by 44% to $51.4 million. Our GAAP net income was $200,000 or $0.01 per basic and diluted share and our non-GAAP cash net income was $4.6 million or $0.16 per basic and diluted share. For the full year we have revenues of $183.1 million, a 35% increase from the year ago. All of our results were in line or in many cases, significantly ahead of our guidance and I think that this is a tremendous accomplishment and testament to the hard work of our employees at Blackboard.

As I said a year ago, our most significant operational priority in 2006 was the successful integration of WebCT. Our team worked incredibly hard in preparing for the transaction and planning the various stages of integration, and as a result our two organizations came together quickly. We have completed the integration of WebCT and I am very pleased with the results. I believe that Blackboard is stronger today than it has ever been and it is in an excellent position for the many opportunities ahead.

As investors, it is important to know, Blackboard business model's primarily driven by; first, our ability to renew our large subscriber base of clients which provides the great operating leverage inherent in our business. Second, our ability to expand our existing client relationships, growing their subscription value overtime by addressing more and more of their emerging elearning needs. And third, our ability to add new client subscribers across the education spectrum, here in the United States and around the world.

In terms of executing against our strategy, we had great success in expanding existing and establishing new relationships with a wide range of different institutions. Following the merger with WebCT, we have established a large footprint across US higher education institutions, which we will continue to expand. I do want to remind investors that the greatest near-term revenue opportunity will be driven by our ability to expand existing relationships to up-selling and cross-selling and that will be our focus for the higher education market in 2007.

A few examples of deals with the US higher education market include, Victor Valley Community College in California with 10,000 students marched yet another two year community college expanding their relationship with Blackboard. In the quarter, Victor Valley upgraded the Blackboard Learning System Enterprise license, it contracted with us for a ASP hosting offering.

Another up-sell in the quarter was the University of Northern Alabama, which upgraded from the basic learning system, to our enterprise Blackboard Learning System Vista License. And while we had a number of great expansion deals in the quarter, the most significant was the North Carolina Community College System. This system, which had previously been running the basic addition of the Blackboard Learning System, adopted the enterprise Blackboard Learning System for nearly 60 campuses in the state. This was a great deal and I believe there's lot of things to come as we work to become the standard on a statewide basis, and while our focus is expanding our existing higher education relationship, we also had several new clients in the quarter, including Aiken Technical College, a public two-year college in South Carolina which is a new client. Aiken licensed the enterprise Blackboard Learning System to serve more than 13,400 students, enrolled in both credit and non-credit courses each year. And another new client Alabama A&M University, which licensed the enterprise Blackboard Learning System to serve more than 6,000 students in it's undergraduate and graduate programs. On the international front, the University of Portsmouth in the United Kingdom is one of our newest client, licensing the Blackboard Learning System Vista License, to serve more than 19,000 students.

On the other side of the world, we are also pleased to welcome Queensland University of Technology as a new client. QUT, which serves 140,000 students, marks another major university in Australia license the enterprise Blackboard Learning System Product. And finally the university of Groningen in The Netherland added the Blackboard Content System to address content in biomanagement issues across their campus.

In K-12, I would like to highlight a couple of deals including the Philadelphia area Independent Schools' Business Officers Association which licensed the Blackboard Academics Suite and our ASP Hosting Offering. This was a good win for us and while the agreement with this organization was for 11 Independent Schools initially, we expect this relationship could grow significantly over time as the organization represents approximately 100 independent schools. Another new K-12 client in the fourth quarter was Anglican Church Grammar School in Queensland, Australia. Anglican Church serves 1700 students and licensed the enterprise edition of the Blackboard Learning System. Also Clear Creek School District in Texas expensed on their enterprise Blackboard Leaning System and moved to the full Blackboard Academic Suite.

For the year we ended 2006 with 3462 clients, an increase of 53% from the prior year. To provide some additional detail of the 3462 subscribing clients, 1906 were US higher education institutions, 900 in EDA were international clients, 405 were in the US K-12 space and there were 163 other organizations which included publishers, commercial education companies, corporations and government organizations. We ended the fourth quarter with a total of 3492 enterprise category licenses. Breaking up these licenses, we had 2180 licenses of the Blackboard Learning System Enterprise, 595 licenses of the Blackboard Community System, 299 licenses of Blackboard Content System and 418 licenses of the Blackboard Transaction System.

In terms of the Blackboard Learning System Basic product, we ended the quarter with 1,298 licenses. The total number of licenses at the end of the fourth quarter was 4,790. The average number of product licenses per client at the end of 2006 was 1.38. We finished the fourth quarter with 455 ASP hosting units, an increase of 31% from last year.

The Company's up-sell rate to our enterprise license of the Blackboard Learning System was approximately 11% in 2006, which was slightly better than our expectations. Our renewal rate, which represents the percentage of renewal dollars collected in the overall pool targeted for renewal for the trailing four quarters was 91%, which was slightly better than the 90% renewal rate which we targeted during the year.

As per contract value, we finished the quarter with an annualized contract value of $163 million. This represents an increase of 59% on a stand alone basis and 19% on a pro forma basis. This resulted in an average contract value per license of $34,000 at an average contract value per client of $47,000. The growth of contract value reflects the strong license sales we had in the fourth quarter.

Blackboard's total headcount at the end of the fourth quarter was 755 people. We ended the quarter with 156 people in sales, 61 in marketing and business development, 146 in product development, 146 in support, ASP hosting and production, 136 of professional services and a 120 in operations. Before I turn the call over to Michael Beach, our CFO, I would like to provide a few comments on some reason events and our plans for 2007.

Last week, Blackboard issued a patent pledge, in which we committed to never serve our course management system pending or issue patents against the development, use or distribution of Open Source Software or home grown Course Management Systems to the extent they are not provided as a proprietary software bundle.

We also promise not to sue many named Open Source Initiatives within the Course Management System space, whether or not they include proprietary components within their application. This announcement is consistent with our prior statements. Though we ultimately determined, that it was in the best interest of the academic community to have a formal written policy. This pledge has been very well received by our current and perspective client base.

Taking a look at the rest of 2007 and beyond, I believe that Blackboard has never been in a better position. We have a great client base that we can grow significantly and an overall market opportunity of more than 30,000 academic institutions worldwide. A meaningful amount of management's focus in 2007 will once again be centered on meeting our clients growing needs and requirements. The primary means of us satisfying these needs are through continued innovation and product development and consistently improving client support. On the product development front, we have been focused on a number of significant initiatives, the most important of which is the availability of all Blackboard Academic Suite products to the entire client base at the launch of the Blackboard Outcomes System.

Our product development team has been working to ensure the availability of all the Academic Suite Products to our entire client base, specifically we are working to make sure the Blackboard Content System, the Blackboard Community System and the newly released Blackboard Outcome System work with the WebCT code base of learning system products. We began the work in mid 2006 and we remain on track to deliver these products in mid 2007. Our sales force has been working with the clients that joined us through the acquisition to build interest in these products and I expect that we will begin to see cross-selling of these products in the second half of 2007 and through 2008.

Additionally the launch of the Blackboard Outcome System has been one of the most important product initiatives we have undertaken. We announced the general availability of the product in mid January of this year which was ahead of our additional plans. We expect that the sales cycle for the Blackboard outcome system will be longer than our other enterprise category offerings, given its premium pricing and we think that the product is highly relevant to our clients. As a reminder, the Blackboard outcome system streamlines the management of the various assessment activities with operational reports of tracking tools that give clear visibility to the numerous assessments taking place across the campus.

The product will allow academic institutions to more effectively and efficiently manage the re-accreditation processes as well as broader analytical reporting capabilities for all institutional stake holders. Dealt more adequately by grace, may an Associate Dean at CN Hall University, a solution like the Blackboard Outcome System is an essential part of the higher education environment today. It provides the institution with an efficient means of data collection connected with other applications that allows us to use multiple resources in making decisions about change and improvements in the curriculum, programs and services we offer to our student. Needless to say, I always appreciate great client references like this one.

I actually think that the most powerful point in racist comment was the notion that Blackboard is an essential part to education. Of course being essential is not just centered on having great products but is increasingly by providing high levels of client support. We will continue to invest substantially in out client support group 2007 as we did this past year. We have invested in support trading organization to rapidly orient new staff and expand the skills of the existing team members.

Additionally we have created a full revised regroup of client to help thrive client experience activity. The feedback from this group is already assisting in developing of key customer services related to business decision of the support team. Our goal is for 100% client satisfaction and we continue to actively engage with all of our clients to ensure the success of their Blackboard implementation. This is all in the course of doing business and we are committed to continually enhancing and improving the experience for our users which investors know in turn drives ongoing sales as well as client retention.

With that I am pleased to hand it over to Michael Beach, our CFO to cover our financials and future guidance. Mike.

Michael Beach

Thanks, Michael. I organized today's review around the income statement, the balance sheet and cash flow and close with the outcome and guidance for the first quarter and full year of 2007. As a reminder, our income statement for 2006 is impacted by the WebCT acquisition including purchase accounting adjustments which reduced the opening differed revenue balance, the increase in amortization expense associated with acquired intangibles and non-recurring integration costs.

The results will follow compare Blackboards 2006 results to our standalone results for 2005. Revenue for the fourth quarter of 2006 was $51.4 million, up 44% over last year. The increase in revenue was driven by continued growth in our annual licensing of enterprise products to clients including clients resulting from the WebCT acquisition. Product revenue for the quarter was $46.8 million representing an increase of 46% over the same quarter last year. Professional Service revenue for the quarter was $4.6 million which represents an increase of 25% over the prior year. In the quarter, Blackboard recognized $2.1 million of revenue related to the opening acquired differed revenue balance from WebCT. This reflects $1.6 million less revenue than WebCT would have recognized as a standalone company.

In terms of revenue characterization, we also break out our revenue by the nature of the revenue streams, which include ratable recurring, ratable non-recurring and other revenues. For the quarter, ratable recurring revenues increased 53% to $39.7 million as compared to $26 million in the same quarter last year. Ratable non-recurring revenues increased 20% to $5.4 million as compared to $4.5 million in the same quarter last year. Other revenues increased 19% to $6.3 million from $5.3 million in the same quarter last year.

Moving on to gross profit, our gross profit for the fourth quarter excluding stock-based compensation and the amortization of acquired intangibles was $37.3 million as compared to $25.2 million in the same quarter a year ago, representing an increase of 48%. For the quarter, our gross margin was 73%.

Total operating expenses excluding the cost of revenues, stock-based compensation and the amortization of acquired intangibles were $28.3 million, representing an increase of 55% as compared to $18.2 million in the same quarter last year. These expenses were in line with our expectations.

Our operating expenses includes the impact of non-recurring integration cost, which includes direct merger-related expenses and cost synergies we expect to realize as a result of combining two similar businesses. In the quarter, the non-recurring integration costs were approximately $1.6 million. For the quarter, we incurred stock-based compensation expense of $2 million, which was lower than original expectations due to higher forfeitures at the end of the year. Amortization of acquired intangibles was $5.4 million.

During the quarter, we prepaid $20 million of our long-term debt. As a result of this prepayment, we incurred an additional $700,000 of interest expense resulting from the acceleration of amortized debt issuance cost. Our net income was $201,000 in quarter resulting in net income per diluted share of $0.01. Adding back the amortization of acquired intangibles, stock-based compensation expense and the associated tax impact, results in non-GAAP cash net income of $4.6 million or non-GAAP cash net income of $0.16 per diluted share.

In terms of the balance sheet, we closed the quarter with $30.8 million in cash and cash equivalents. We plan to use certain excess available cash balance to reduce our outstanding term loan which was $24.4 million at the end of the fourth quarter. Accounts receivables increased to $52.4 million at the end of the quarter from $26.1 million for the same quarter last year. Our DSOs have increased compared to Q4 2005, primarily as a result of invoice timing and part due to renewal timing for clients resulting from the WebCT merger. Q4 DSOs are more indicative of what we would expect for Q4 in the future.

Current deferred revenues increased up to $118 million at the end of the fourth quarter, up 57% from the $75 million at the end of the fourth quarter last year. Current deferred revenues related to recurring products totaled $102 million compared to $62.1 million for the same quarter last year representing a 64% increase.

Cash flow provided by operations totaled $11.2 million for the fourth quarter. Investors should be aware that in addition to the non-recurring integration cost of $1.6 million we also paid approximately $4 million for perpetual license of a technology incorporated in one of our products, which will decrease sublicensing cost beginning in 2008. Finally, capital expenditures were $1.9 million in the fourth quarter of 2006.

Now, turning to the full year income statement. For the year ended December 31st, 2006, revenue was $183.1 million, an increase of 35% over 2005. Net loss was $10.7 million or $0.39 per basic share. Non-GAAP cash net income which excludes the amortization of acquired intangibles and stock-based compensation expenses net of taxes was $6.5 million or $0.22 per diluted share.

I want to call everyone's attention to a change we are making related to some non-GAAP details that we will provide on an ongoing basis. Beginning in the first quarter of 2007 Blackboard management will begin providing financial guidance and reporting on two new non-GAAP financial measures, non-GAAP adjusted net income and non-GAAP adjusted net income per share, which exclude the amortization of acquired intangibles and the associated tax impact. These measures will replace non-GAAP cash net income and non-GAAP cash net income per share which the company has previously provided.

For the first quarter 2007, we expect revenues of $53 million to $54.2 million, amortization of acquired intangibles of $5.4 million. Net income of $1.3 to $1.8 million, resulting in net income per diluted share of $0.4 to $0.6, which is based on an estimated 29.5 million shares and an effective tax rate of 41.5%, and non-GAAP adjusted net income excluding the amortization of acquired intangible and the associated tax impact of $4.4 million to $4.9 million, resulting in non-GAAP adjusted net income per diluted share of $0.15 to $0.17, based on an estimated 29.5 million shares and an effective tax rate of 41.5%.

For the full-year 2007, we expect revenue of $230 million to $235 million. Stock-based compensation expense of $13 million, amortization of acquired intangibles of $22 million. Net income of $10 million to $12 million, resulting in net income per diluted share of $0.33 to $0.40, which is based on an estimated 30 million shares and an effective tax rate of 41.5%. And non-GAAP adjusted net income excluding the amortization of acquired intangibles and the associated tax impact of $22.5 million to $24.5 million, resulting in non-GAAP adjusted net income per diluted share of $0.75 to $0.82 based on an estimated 30 million shares outstanding and an effective tax rate of 41.5%.

A few additional comments related to the guidance I have just provided. Previously, we've provided some directional guidance on operating margins, cash flow. and CapEx. So I want to take an opportunity to provide an update. On our last call, we indicated that our EBITDA margins for 2007, which exclude amortization, stock-based compensation, would approach the low-end of our target range of 25% to 30%. I would like to reaffirm that statement by saying that -- saying more clearly that we expect these operating margins to be in the range of 23% to 24% for 2007.

Our expectations for 2007 are that cash flow from operations should increase somewhere between 250% to 280% over 2006. As you know, historically, CapEx has run between 6% to 7% of revenue, we expect CapEx to be approximately 8% of revenues in 2007, due to the onetime expenditures related to our relocation of our corporate headquarters. We would currently expect CapEx to return to 6% to 7% range in future years. We currently estimate a cash tax rate of approximately 20% for 2007, given the benefits of our expected use of NOLs. I would like to note that our cash tax rate will vary materially resulting from factors which include our earnings mix between domestic and international operations, as well as tax planning which may result in changes to our available net operating losses. This concludes the discussion of Blackboard's financials. Now, let me hand it back to Michael Stanton for closing, Michael?

Michael Stanton

Thanks, excuse me, thanks Mike. We are on the road this week in San Francisco for a couple of conferences including the Thomas Weisel Partners Tech Conference tomorrow, as well as the Credit Suisse Disruptive Technology Conference on Thursday. Additionally, we are also going to representing at the Merrill Lynch 2007 Internet Software and Services Conference, and the Banc of America Technology Conference, both of these in New York, the following two weeks. That takes care of it for us. Let's get to your questions. Operator, why don’t you set up the queue and we will start Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Kirsten Edwards with ThinkEquity Partners, please proceed.

Kirsten Edwards - ThinkEquity Partners

Hi, good afternoon and great quarter. One quick house-keeping, can you give us the number of quota bearing sales rep now and what the plans are for that number throughout ’07?

Michael Beach

Yes. At the end of the year -- we ended the year with 73 quota bearing reps, we do expect that to increase approximately 10% during 2007.

Kirsten Edwards - ThinkEquity Partners

Okay great. And then, my other question actually regard to the Board, I think you had one departure recently and wondering if you'll give us an update on your plans to fill that spot, and if so what type of expertise you are looking for?

Michael Beach

Yes we did have a individual leave the Board, and we are currently undergoing a search to add additional directors to the Board. Really we are looking at people with a wide range of backgrounds, everything from expertise in enterprise software companies to the education space. The search is underway and we are hopeful that we would have a new member in the upcoming month. The individual that stepped off the Board was Steve Gruber from Oak Hill. They had pretty much sold out their position and needed to be able to free-up his schedule. So he has stepped off the Board, but we are hopeful we will have this position filled relatively shortly.

Kirsten Edwards - ThinkEquity Partners

Okay. And the plans to keep the same composition of the Board in terms of number of seats?

Michael Beach

Currently, that is our plan.

Kirsten Edwards - ThinkEquity Partners

Okay. Great, thanks a lot.

Operator

Your next question comes from the line of Michael Nemeroff with Wedbush Morgan Securities. Please proceed.

Ariel Schochet - Wedbush Morgan Securities

Hi, guys. This is [Ariel Schochet] calling in for Michael Nemeroff.

Michael Chasen

Hi there.

Michael Beach

Hello.

Ariel Schochet - Wedbush Morgan Securities

Hi, a couple of quick questions. The first question, just wanted to get a sense of the next product. Are you guys going to have an assessment tool that focuses on the K-12, kind of a paradigm versus an outcome system?

Michael Chasen

Well, actually the Blackboard outcome system product is both for higher education as well as the K-12 market space. And very specifically goes towards the -- that you had mentioned. We have a lot of our clients that are really looking at doing detailed analysis on all of the e-Learning data that they've collected, not only to be able to improve their own schools, teaching and learning processes, but also to make sure that the goals that are set for the school are in line with both state and federal standard and regional and state and federal testing requirements. So the outcome system product is very much so, I believe is going to be a product, directly targeted at the K-12 space as well as the higher education space.

Ariel Schochet - Wedbush Morgan Securities

Great, thank you and good quarter again.

Michael Chasen

Thank you very much.

Operator

Your next question comes from the line of Kash Rangan with Merrill Lynch. Please proceed.

Kash Rangan - Merrill Lynch

Hi, thank you very much. Nice quarter. Just a couple of clarifications, one is when I look at the operating margin, not the EBITDA, but the operating margin implied by the midpoint of your EPS, the cash EPS or the adjusted EPS guidance, accounted roughly 18.3%, 18.4 %. That's roughly where you finished up fiscal '05 before the merger. Out of that that you would have gotten even more merger synergies and therefore an option to expand your margins. I am just wondering, how you think about your business in 2007? Are you still in the investing mode and that therefore we should be looking into '08, where you get that 23%, 25% operating margin, if not EBITDA margin. Then I have a follow-up question thanks.

Michael Beach

Yes. So as a couple of things here. First, as you look at the comparison, stock-based comp is included in the '06 results and '07 results and clearly increasing, which is impacting the margin. As you look at our operating expense line items, we expect that if you look at the run-rate that we ended Q4 of 2006, we would see increased leverage in each of those line items of approximately a percentage point of revenue across each item.

Kash Rangan - Merrill Lynch

What items are those exactly?

Michael Beach

If you look at G&A, sales and marketing.

Kash Rangan - Merrill Lynch

Okay I got it. Okay.

Michael Beach

As you go across those -- the operating expense line items, G&A, sales and marketing, R&D as a percent of revenue. We would expect it to be roughly a point lower in '07 than what we experienced in Q4 of '08. So we do expect to have leverage across the line items excluding the stock-based comp.

Kash Rangan - Merrill Lynch

I got it, got it. So we were to exclude the stock-based comp then what is roughly your operating margin in period implied by your EPS guidance?

Michael Chasen

I am sorry can you repeat the question?

Kash Rangan - Merrill Lynch

If you exclude the stock base comp what is the true apples-to-apples operating margin implied by your guidance of fiscal 2007?

Michael Chasen

23%, 24%.

Kash Rangan - Merrill Lynch

Okay. So that's what you said. Alright. The second question is the patent issues, is that having any impact on your business? How do you explain the prospects and current customers, where you stand on this issue and any thoughts there if you could share?

Michael Chasen

Sure, as I mentioned on the call, we recently actually put out a patent pledge and I think that was an opportunity for us to be able to put in writing what we have been saying for a long time and our commitment to not pursue -- to not focus on institutions that are using homegrown assistance or open source solution. Really, we haven't seen an effect in any of our sales, because I think our numbers speak for themselves for the quarter and the year. We actually have our Chief Legal Counsel, Matthew Small, on the line, let me actually also defer to him to be able to expand upon that question. Matthew.

Matthew Small

Sure, as Michael said, we have had no negative sales consequences to date regarding the patent action. Although certainly, its something people are talking about as Michael also said. We have consistently maintained that -- we are not focused on schools or open source or homegrown assistance or a lot of that the things that people were speculating about, all of which were really unrealistic hypothetical scenarios, and the community asked us to put it in writing, which we did in a pledge and it has been very, very well received and we have heard tons of feedback from our client, basically saying, Bravo Blackboard, thank you for doing this, and we think that will alleviate that concern and going forward and reduce that conversation.

Kash Rangan - Merrill Lynch

Great, thanks. Michael, may be if you could just finish it up with any qualitative, quantitative observations on the WebCT side since you have the business for year? What is your observation of client retention and also important sales people retention on the WebCT side? Congrats again, thanks.

Michael Chasen

I think we have been -- thus far actually have been ahead of our, both, projections and plan when it comes to both client retention on the WebCT side as well as the success of the sales team. So, we are very pleased with where we are today. We think it puts us in a very strong position for 2007 to go back to all those existing clients, and be able to cross-sell and then up-sale them, the Blackboard Community System, the Content System and the Outcome System as soon as they become available. So, I think we are very excited about the positioning and think that the acquisition has gone extremely well and prepares us well for 2007.

Kash Rangan - Merrill Lynch

Great, thank you very much.

Operator

Your next question comes from the line of Amy Junker with Robert Baird. Please proceed.

Amy Junker - Robert Baird

Hi, good afternoon. A couple of questions on the Outcomes Product, are you currently grouping Outcomes as part of your learning systems or is that going to constitute entirely new suite?

Michael Chasen

The Outcomes System is yet another product that we offer. We do call all of the products, the Blackboard Learning System, the Blackboard Community System, the Blackboard Content System, as well as the Blackboard Outcome System as part of the overall chain brand under the Blackboard Academic Suite, these all are software that really directly help institutions bring their academic and e-Learning needs online. So, it is another product offering and within next suite of software that we offer. It is really also a software that is not only an extension to the Learning System, the Community System, the Content System product that allows you to do detailed reporting in data analysis on those product but as well on metrics that you may be accumulating within the institution. It allows for everything from reporting on (inaudible) help what the Institution's accreditation process.

Amy Junker - Robert Baird

Great, and can you tell us, even if it's roughly, if you have signed or how many licenses you have signed so far and I guess I am curious given, the higher price point, has anyone come back to you and said that they would like to buy it, but the costs is too prohibitive?

Michael Chasen

Well the sale cycles of the Blackboard Outcome System is a little bit longer than our other products, do in-part because I think of the increased license fee as well as due to the fact that we are dealing people that are higher up in the institution in many cases, the presidents or [progress] of the institutions. However we haven't really have pushed back on the pricing point. We think that the value we are delivering is certainly commensurate with the licensing cost. And we just launched the products, so we are still very early in this sales cycle, but are engaged in conversations with many clients.

Amy Junker - Robert Baird

And just last question for me on a separate topic. In terms of your guidance, you mentioned you expect to do some cross-selling to the WebCT customers in the second-half. How much of that are you baking into your guidance?

Michael Chasen

Well you have to remember that, because of the licensing model that we have, even though we are expecting a good number of sales in the second-half, it really won't have a significant impact on revenue until 2008, just because of the differed nature of the license fees. So, we are starting to build up a good pipeline. We think that we will be able to realize that once the product comes to market, that it won't have a large revenue effect until 2008 and beyond.

Amy Junker - Robert Baird

Great. Thanks so much.

Operator

The next question comes from the line Howard Block, Banc of America Securities. Please proceed.

Howard Block - Banc of America Securities

Thank you operator, congratulations, nice quarter, nice year, nice outlook. First question though is, I actually want to ask Matthew smaller just to follow up on the comment. You had -- you said it is those something people are talking about, you mean people like us in the investment community or people in your market?

Michael Beach

Good question Howard. I was referring to people in our market clients and other commentators in the e-learning industry who had questions around the patent regarding its scope, and its validity and our intentions and I think we've been able to answer all three of those to their satisfaction.

Howard Block - Banc of America Securities

Okay but again, I just want to be careful, so when you had said that, made that comment about something people are talking about, was right after someone had speculated that there might be some backlash in the customer's side in terms of business. So you are saying it's just being discussed, but you haven't necessarily seen any backlash or ramifications or consequences in the sales channel?

Michael Beach

That’s correct. We have not seen any backlash in our sales. It was a conversation that was coming up a lot and people were asking whether or not we could put our assertions in writing. So, we felt it was important to listen to the community and to provide that assurance to make sure that it didn't become a backlash in the future and also to be a responsible member of our e-Learning community.

Howard Block - Banc of America Securities

Okay. A couple of quick housekeeping, the guidance you offered Michael, does that includes the stock based comp, I mean there's no longer any need to mention it excluding or with without it, we should just assume that the guidance include stock based comp?

Michael Beach

Yes.

Howard Block - Banc of America Securities

Okay. And then in terms of '07, is there any noise around further non recurring integration costs or lost deferred revenue that sort of bleeding out, maybe right at the end of the first quarter or even into the second, can you quantify the noise I guess?

Michael Beach

It's out of the numbers.

Howard Block - Banc of America Securities

Completely?

Michael Beach

Yes.

Howard Block - Banc of America Securities

So 1Q '07 is clean as (inaudible) because you had mentioned I think in the last call, there is a good chance some might be in the first quarter?

Michael Beach

Yeah, no, no, we don't expect any material in the first quarter.

Howard Block - Banc of America Securities

Okay

Michael Beach

Q1 is pure.

Howard Block - Banc of America Securities

And so, then -- I don't have all the numbers right in front of me, but the total for the year that was lost in '06 was about 15 million?

Michael Beach

It was 13.8.

Howard Block - Banc of America Securities

13.8, okay. So, if we -- would it be fair then may to, let's just say, if we wanted to just sort of get what sort of organic growth is embedded in your '07 guidance. We added that amount to let's say to the base year, meaning ’06 and looked at what your '07 guidance is implying. It's implying roughly 18% revenue growth. Is that a fair way to think about what your guidance is implying?

Michael Beach

Yes

Howard Block - Banc of America Securities

Okay. And is that -- it's a very healthy growth rate but is that sort of a -- I expected the guidance to be a little bit more back-loaded in terms of expecting the cross-selling to really manifest more in the 3Q and certainly 4Q numbers, but yet it feels like we are starting off the year at this robust growth rate. Is that -- my reason is correct one?

Michael Chasen

No, I think in general the company is in a good position for 2007 and that's going to be relevant throughout all of the quarters. And while we certainly expect to see a pickup in the cross-selling and the up-selling in the later half of the year, that really isn't going to have a large revenue effect until the following year. So, I think that's why you are not seeing a big difference on whether the numbers are more backend loaded or not.

Howard Block - Banc of America Securities

Okay. So, where we may see evidence manifest would be in contract value certainly and possibly a little bit in deferred but not in revenue?

Michael Beach

I think that's correct. I mean again, you will see a little bit of revenue, but obviously the majority I think will -- the effect will really be in 2008.

Howard Block - Banc of America Securities

Okay. And then, was there anything -- and again, I haven't had a chance to look at this very closely, if I missed something, I apologize, but in the cash flow from the quarter, obviously deferred revenue was strong. I understand the DSOs are where they are. Anything in cash flow outside of those two balance sheet items that might explain in what looked to be a little bit of a disappointment?

Michael Beach

The big item is the $4 million perpetual license we discussed earlier. We have technology embedded in one of our products and we purchased a perpetual license related to that technology. Historically, we've licensed annually with that provider.

Howard Block - Banc of America Securities

Okay.

Michael Beach

And so, the net impact is lower cost of sales moving forward, but we did have to make a large payment upfront and that hit the quarter.

Howard Block - Banc of America Securities

Okay. And then, if you can help, this non-tech, I understand the implications for that license on the gross margin in '07 and maybe the comparison I guess to '08?

Michael Beach

Yeah, it won't have a material impact in '07. Really '08 and subsequent years is where it will have a more material impact. There was another item that impacted cash flow that I didn't discuss. Historically, we have an international client consortium that historically has paid us in the last week of December about $3 million receivable. And this year actually we paid it in January.

Howard Block - Banc of America Securities

Okay.

Michael Beach

So, there was kind of $3 million split based of a payment of a week.

Howard Block - Banc of America Securities

Okay. So, that obviously had an impact on DSOs as well?

Michael Beach

Correct.

Howard Block - Banc of America Securities

And so, along those lines could you tell us what the international revenue was in the quarter?

Michael Beach

Yeah, international revenues $10.5 million, $10 million of that product revenues and the remaining amount was service.

Howard Block - Banc of America Securities

Okay. And sorry, last thing, any I just sort of general or directional guidance in terms of gross margins for '07 sort of implied by the guidance?

Michael Beach

Yes, our target gross margin has been in the 70% to 75%, and I would expect this year to be in the middle of that range.

Howard Block - Banc of America Securities

Okay. Great. Again, congratulations guys. Thank you.

Michael Chasen

Thank you very much, Howard.

Operator

The next question comes from the line of Trace Urdan with Signal Hill. Please proceed.

Trace Urdan - Signal Hill

Thanks. Good afternoon. When WebCT customers come up for renewal on their existing product, are they effectively paying a comparable price to what they paid before or is there any kind of an uptick to sort move them in line with the Blackboard pricing?

Michael Beach

They are generally paying a price that's comparable to what they historically have paid. The WebCT and Blackboard pricing is not dramatically different.

Trace Urdan - Signal Hill

Okay. And I think there was something like one-third, two-third split in the WebCT customer base between the basic and the enterprise products, is that -- have you seen significant migration from the basic to the enterprise or is everybody sort of holdings steady there?

Michael Chasen

I think basically what we've seen is relatively the same type of up-selling percentages that we've actually had historically at Blackboard. So inadvertently, I would say right around 10% or 11% of the WebCT installed base, I think, closer to 11% has actually been up-selling through their enterprise products. So both of the client bases, both the Blackboard as well as historic WebCT act pretty similarly in this aspect.

Trace Urdan - Signal Hill

Okay, and then do the WebCT's customer base and they -- is there anything that they are waiting for before the -- the sort of the process of migrating them over on to a common platform continues, or have you already sort of presented a roadmap to them, or they're still waiting for anything in that regard?

Michael Chasen

Sure. What we've been talking about and engaged in conversations with a large amount of our clients over the last couple of months as we work to finalize our longer-term product strategy roadmap and even though we have been discussing it informally, we are now putting together kind of a more detailed roadmap with all that feedback and the discussions that we have been involved in and will be rolling that out over the upcoming weeks and months. But one of the things we have been consistent about in both the formation of that roadmap as well as the conversations we have had is that, we are not looking to migrate the WebCT installed base from one loading system to another. What we are really doing is taking advantage of the similar architecture and the similar both code base of the products and looking to over time merge the products through the natural upgrade process that they currently are used to, so they don’t really have to worry about going through any migration. Now, if you would ask me what are the WebCT clients currently waiting for or looking for? My answer to that would be both The Blackboard Community System, The Blackboard Content System, as well as The Blackboard Outcome System, which will all be available -- made available to WebCT clients in the latter half of this year.

Trace Urdan - Signal Hill

Okay. So when you're talking about cross-selling and up-selling in pipeline that’s -- it's really those products that you are referring to?

Michael Beach

Yes, we are looking to be able to enable the WebCT clients to expand the features and functionality of products by keeping their current loading system but expanding with our other products within the suite, the community system, the content system, and now the outcome system.

Trace Urdan - Signal Hill

Okay, and that -- will it be formal sort of product launches in that respect or is it going to kind of leak out slowly, as you're in conversation with them or could we expect to see press releases associated with those?

Michael Chasen

Certainly, as soon as those products are available, we'll make sure to properly roll them out, put up associated press releases and get out both to our clients as well as the investor community those are available. We have been in conversation with our clients. They know that this is the direction that we're headed in and when to generally expect to see these products made available for them. And we'll be rolling it out as soon as they become available.

Trace Urdan - Signal Hill

Okay, thanks for your help.

Operator

Your next question comes from the line of Brandon Dobell with Credit Suisse. Please proceed.

Brandon Dobell - Credit Suisse

Hi, thank. A couple of quick ones, as you think about the service revenue line this year, any reason that we should it will be different what we have seen, any kind of recent seasonal patterns, or recent percentage of sales comparisons, anything that like -- in the back half year with more new products out there, should we expect to see that change at all?

Michael Beach

Brand, I think we expect it to be consistent with what we have experienced in the past somewhere in 11% to 12% of total revenue and the seasonality similar to what we experienced. I think as a percent of our revenue obviously there is the deferred revenue that was getting added back during the year, so '07 will be different than '06, but the same basic trend should continue.

Brandon Dobell - Credit Suisse

Okay. In the same direction, it looks the international markets, anything different there from a service needs or gross margin perspective now, I think, is a decent chunk of your guides revenue, is it materially different from what we would see in the US with the [high-rate clients]?

Michael Beach

I think from a profitability standpoint, not much different, I clearly the international clients have acquired less services historically than the domestic clients. So, there is a slight decrease in the proportional amount of services to product revenue internationally.

Brandon Dobell - Credit Suisse

Okay, okay. And then with the hosting clients maybe a bit of an update there on, what those deals were looking like? What kind of solutions you are deploying there, is it for on ground or online, any kind of that - the breadth of those installations relative what we see at -- at a traditional kind of on-site clients?

Michael Chasen

With our hosting clients, we're really seeing a two general trends. The first is that more and more new client, as were speaking to them about setting up their e-Learning products and putting it in place to be able achieve their long-term strategies are selecting our ASP hosting because they believe that over the long run, we've both the infrastructure, the investment, and the expertise to make sure that they are -- they are roll out in their program is successful. But another big trend we are seeing is the fact that more and more of our existing client are really I think reaching the limits of their ability to be able self manage these program that are be coming incredibly successfully on our their campuses and so have talked with us about immigrating their programs from their campus run sites to our hosting facilities to be able to take advantage of the infrastructure that we have to scale and again the expertise in running the product. So, I think, we are seeing positive trends on both fronts.

Brandon Dobell - Credit Suisse

Okay. And then from a financial perspective, size of deal, profitability of deal, service component, how should we think about the impact of let's say it's a real big migration from onsite to a hosted, what does that do for your guides business?

Michael Chasen

The hosting business certainly has strong margins and additional revenue because they are still paying the license fee and the services fee as well as the ASP hosting fees.

Brandon Dobell - Credit Suisse

Okay.

Michael Chasen

So, what we do see from the hosted client is that they have a higher amount of retention and they have a potentially lower support cost because the whole thing is professionally managed. But in general, otherwise, it wouldn't differ from clients that otherwise have it hosted locally. And the migration usually can be done without extensive amount of services work. So, we don't think that there is anything really meaningful there, but certainly it has some additional opportunity to increase the overall value of a client subscription as well as make sure that their site is run at a higher level of scale and with fewer problems taking advantage of that infrastructure investment being made.

Brandon Dobell - Credit Suisse

Okay. And then final question, as you think about the '07 guidance in the top line, anything that we should know about in terms of a change in trajectory for the different licenses you guys have or retention assumptions, up-sell assumptions things like that and then also your pricing just comes in kind back half of the year, but what else should we think about in terms of getting comfortable with your outlook for the top line?

Michael Chasen

I think that if you take a look back over the last several quarters, our numbers really have been very consistent, both in retention rate, as well as up-sell rate and cross-sell rate. Also you could take comfort in the fact that both the Blackboard and the WebCT client bases are very, very similar or act in similar ways. So, I think our projections going forward are really based on the historical experience we've had relative to those up-sell, cross-sell and retention perspective number. However, certainly we don't yet have the full product suite out yet to be able to cross-sell and up-sell into the WebCT installed base. Certainly, also historically, the WebCT retention number had been slightly lower than the Blackboard retention number by a percent or two, but I think that those really end up kind of smoothing at over time and otherwise put us in a good position to be able to achieve our 2007 results.

Michael Beach

And I think as the year progress, it is clearly the introduction of products cross-selling to the WebCT customer base that is going to be a focus and kind of a new opportunity that will impact revenues towards the end of the year and into '08.

Brandon Dobell - Credit Suisse

Okay. Great, thanks a lot.

Operator

(Operator Instructions). The next question comes from the line of Tom Roderick with Thomas Weisel Partners please proceed.

Tom Roderick - Thomas Weisel Partners

Hi guys, good afternoon. Thanks a lot. Michael, I wanted to ask you just a quick question here on the cash flow from operations guidance, pretty strong number you are guiding up 250% to 280%. Can you walk us through some of the assumptions you are making, perhaps from a DSO standpoint or other assumptions you are making outside of the top and bottom line guidance on the income statement to help us get there? Thanks.

Michael Beach

From a DSO perspective, no major changes over kind of level that we have got at the end of the year. But I think what's important to notice in '06 is cash flow was negatively impacted the merger costs and the things that we just discussed the $4 million perpetual license addition and the surf or the client internationally who paid us in '07 rather than '06. So, those items when you factor them into '06 I think gets you to a growth rate that is more reasonable and probably something that you would look at and get more comfortable with. So, I think really the '06 number once you normalize with the '07 for it makes sense.

Tom Roderick - Thomas Weisel Partners

Okay. So, no anticipated changes in the way you go about collections or anything that you are assuming gets much better in that environment. These are numbers you can hit without changes on the collection side?

Michael Beach

Yeah, I mean we are always obviously always trying to kind of improve our processes and get the DSOs down, but I don't expect significant improvement over the numbers that we've shown this quarter.

Tom Roderick - Thomas Weisel Partners

Okay. And maybe just turning attentions to the transactions system, why don't if you could just give an update on how the two businesses trending with respect to how the Transaction System is sold these days? Again, if you just give a little bit of detail in whether you anticipate up-selling that to the WebCT installed base and are you getting some synergies across respective sales forces between the core learning products and the Transaction System itself?

Michael Chasen

Sure. Certainly, the growth of the Commerce Suite and the Transaction System continues to go along and meet our expectations. I think one of the areas where we're starting to really see the synergy between the Academic Suite and Commerce Suite is in the Blackboard Community System product, which is the portal product that allows institutions to [play] everything kind of outside of the course environment online and what that includes is allowing institutions to put the transactions that happens on campus, whether its items that they would upload for self, and the campus bookstore or other items that students would then be able to purchase with their campus card. Now right now, that works through the Blackboard Community System linking in with the transaction system to allow these transitions to occur online with the university card and certainly as we move forward and the community system is then available for WebCT client, WebCT clients will then also of the transaction system. I think we would able to also take advantage of this great feature sets. So from there, we're really starting to see some pick up in the sales of the community system product because of the crossover potential between the suite. And certainly as well there are other benefits of integration between the suites that we would to look to make happen with the WebCT client as well, but again I think really the focus for ’07 is immediately getting the other academic suite products, first to run an interface with the WebCT installed base and then we will continue down to work to have tight integration across the full set of products.

Tom Roderick - Thomas Weisel Partners

That’s great. Thanks so much. That’s it from me.

Operator

There is a follow-up question from the line of Howard Block with Banc of America Securities. Please proceed.

Howard Block - Banc of America Securities

Just a quick question on the cash flow guidance. It certainly is robust, but believe it or not, we estimated a bigger number. And I think one of the significant variance is that we probably just misjudged what your cash taxes would be in the year. Can you -- I know you guided to sort of tax provision, but can you give us s sense maybe what your real cash taxes may be?

Michael Beach

Okay. So, we would expect cash taxes for the year to be about 20%.

Howard Block - Banc of America Securities

Okay.

Michael Beach

And that’s getting driven by -- if you look at the NOLs at the end of the year, we would have ended the year with slightly over a $100 million in net operating losses, of which over $14 million would be available for use in the year, but obviously and some of our amortization expense that runs to the P&L is not deductible. So when you net the amortization expense off of that $40 million of benefit from the net operating losses, we end up with a cash tax rate of about 20%.

Howard Block - Banc of America Securities

Okay, that’s helpful. And then I am sure that my able associate knows this answer, but I can't get it fast enough from them, what's your guidance for stock-based comp for '07?

Michael Beach

13 million.

Howard Block - Banc of America Securities

13 million. Okay. Is that down a little bit from before or no?

Michael Beach

Yes, that’s down -- it's down about $2 million from the guidance we gave you previously.

Howard Block - Banc of America Securities

Got you. Great, very helpful. Thank you.

Michael Beach

Okay.

Operator

Your next question comes from the line of Richard Baldry with First Albany Capital. Please proceed.

Richard Baldry - First Albany Capital

Thanks, just sort of wondering philosophically while you're pulling stock-based comp number out, it looks like if you were to tax it, it's still over a $0.25 to $0.30 adjustment that will leave your guidance well north of a buck a share on the year. So -- sort of what was driving that decision making process? Thanks.

Michael Beach

So, over the past few quarters we received a number a questions, number of requests from analysts and investors to provide a non-GAAP measure that was more inclusive given the increasing requirement for some -- for research analysts is to include stock-based comp in their estimates. We decided that this was the best way to address the issue. We will continue to provide the stock-based comp as necessary to be added back, but we thought this was the most appropriate disclosure going forward.

Richard Baldry - First Albany Capital

And then, written down that 250% or 280% of [free flow] cash from ops, just to make life easy I wondering can you back that into a hard dollar number? And then, talk a little bit major adjustments are strictly related to stock-based comp and non-cash taxes or after other major adjustments trying to leave aside things like working capital that over time should really blend out? Thanks.

Michael Beach

So the guidance gets you to roughly $55 million to $60 million with cash from operations and there is no large items flowing or unusual items flowing through. The only -- obviously we do get some level of benefit from the lower tax -- cash tax rate there, effective rate from a tax provision and there is a slight impact from the new corporate headquarters, a little bit of lease overlap in the fourth quarter, which would have a negative impact, but outside that no large unusual items.

Richard Baldry - First Albany Capital

And giving the recurring nature of the business, it doesn’t seem like it would need a lot of cash on the balance sheet to operate fairly efficiently, so coming into the second half when you could probably have eliminated the terminal entirely and I wondering if management has any philosophy or things like buybacks or other ways to use efficiently cash? Thanks.

Michael Chasen

We continue to examine the best ways to be able to utilize our cash. Certainly, we have no specific plans on doing any of those things that you mentioned currently. But we constantly examine our overall position.

Richard Baldry - First Albany Capital

Thanks and congratulations.

Michael Chasen

Thanks.

Operator

There are no additional questions at this time. I would now like to turn the presentation back to Mr. Michael Stanton for closing remarks.

Michael Stanton

Thanks Lisa and thanks everyone for joining us for us for the year-end call. We'll speak to you at the end of the first quarter. Take care. Thank you everyone.

Michael Chasen

Thanks.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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