Blackbaud's (BLKB) CEO Mike Gianoni on Q2 2016 Results - Earnings Call Transcript

| About: Blackbaud, Inc. (BLKB)

Blackbaud, Inc. (NASDAQ:BLKB)

Q2 2016 Results Conference Call

August 02, 2016 08:00 AM ET

Executives

Mark Furlong - Director, IR

Mike Gianoni - President and CEO

Tony Boor - EVP and CFO

Analysts

Steve Ashley - Robert W. Baird & Company

Tom Roderick - Stifel Nicolaus

Brad Sills - Bank of America Merrill Lynch

Justin Furby - William Blair

Ben McFadden - Pacific Crest

Kevin Liu - B. Riley

John Rizzuto - SunTrust

Ryan MacDonald - Wunderlich Securities

Patrick Falzon - Evercore ISI

Operator

Good day and welcome to the Blackbaud 2016 second quarter conference call. Today’s conference is being recorded.

At this time, I would like to turn the conference over to Mr. Mark Furlong, Director of Investor Relations. Please go ahead, sir.

Mark Furlong

Good morning, everyone. Thanks for joining us on Blackbaud’s second quarter 2016 earnings call. Today we will review our Q2 financial and operational results, provide commentary on our performance through the context of our five-point growth strategy, and discuss progress against our 2016 financial guidance and long-term aspirational goals.

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

Please note that our comments contain forward-looking statements subject to risks and uncertainties that could cause actual results to differ materially from those projected. Please refer to our most recent Form 10-K and SEC filings for more information on those risks. We believe that a combination of both GAAP and non-GAAP measures are more representative of how we internally measure our business.

Unless otherwise specified, we will refer only to non-GAAP financial measures on this call. Please note that non-GAAP financial measures should not be considered in isolation from or as a substitution for GAAP measures. A reconciliation of GAAP and non-GAAP results is available in the press release we issued last night and a more detailed supplemental schedule is available on our investor relations website.

Before I turn the call over to Mike, I will briefly cover our upcoming investor relations activities, which is available on the events section of our Investor Relations website. Investor day will be held in conjunction with our user conference, bbcon, on October 27, in Washington, DC. Registration is currently open and available on our investor relations website.

During the third quarter, our team will be attending the Pacific Crest conference in Vail and Canaccord conference in Boston. We also will be meeting with investors in Minneapolis, New York, and Toronto. Please reach out to investor relations if you are interested in connecting at one of these events.

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

Mike Gianoni

Thanks, Mark. Good morning, everyone. Thanks for joining our call today. I’m pleased to report a solid second quarter that positions us well to achieve our full-year 2016 financial guidance, which we have revised slightly operating cash flow. Tony will provide more detail on our financial results and, as usual, I will provide an update in the context of our five-point growth strategy. So let’s get started.

The first of our five strategies is what we call integrated and open solutions in the cloud. Last month, Microsoft’s worldwide partner conference, which draws approximately 75,000 partners, customers, and employees, featured Blackbaud SKY on the main stage as a leader in cloud innovation. Blackbaud SKY is our new, modern, integrated, and open cloud. It serves as the foundation of our next-generation solutions, combining infrastructure, processes, and pre-integrated services like payments and analytics to deliver total solutions that help our customers achieve their highest potential.

This quarter we expanded that set of pre-integrated services with SKY Reporting moving from limited availability to general availability for Raiser’s Edge NXT. SKY Reporting is our new business intelligence and reporting capability that will seamlessly deliver valuable insights and productivity enhancing capabilities, like real time report access, dashboards, and integrated drill downs. Over time, SKY Reporting will steadily be integrated into the entire portfolio of Blackbaud’s SKY powered solutions, adding to the rich set of features and functionalities offered by our next generation solutions.

In fact, we previewed SKY Reporting at our annual K-12 user conference in Boston a couple of weeks ago. We demonstrated consolidated reporting from multiple solutions including Raiser’s Edge NXT, Financial Edge NXT, and our WhippleHill solutions. The feedback was overwhelmingly positive and we’re excited at the K-12 Early Adopter Program, which we will introduce later this year. We also crossed a key milestone in Q2 by officially launching our partner beta program for SKY API, a key capability of Blackbaud SKY. SKY API moves Blackbaud into an open source architecture for the first time with industry standard rest APIs that will allow customers, partners, and application developers to extend functionality and integrate with our solutions.

In conjunction with this initiative, we’ve created a world class developer portal to enable users to easily leverage the API endpoints which includes resources like code samples, sandbox environments, and community support. The developer portal has been receiving high marks from the tech community and we’re looking forward to sharing it with our customers later this year in the customer beta program launch. I will add that an open architecture is also allowing our own engineering teams to move at a much faster pace as we continue the effort to tightly integrate the portfolio.

Our progress on the integration of Smart Tuition with Financial Edge NXT is a great recent example of that effort. We also announced the acquisition of Attentively in early July shortly after we closed Q2. Attentively was in the Blackbaud partner program, integrates with Luminate online, and provides social marketing software to conduct social listening, identify key influencers, and drive engagement. Social giving is a fast growing fundraising channel that can have a very meaningful impact to our customers’ top line. Susan G. Komen, for example, identified 27 social influencers that helped raise $200,000 at a single event by leveraging Attentive.ly technology. This tuck in acquisition with roughly a dozen employees accelerates our ability to deliver pre-integrated social capabilities with Blackbaud SKY and we’ll begin with Luminate next gen.

Now let’s turn to our second strategy, which is driving sales effectiveness. We’re committed to continue creating a world class sales organization at Blackbaud to drive healthy top line growth and penetrate our large market opportunities. You can clearly see the investments we’re making in the sales, marketing, and customer success line on the P&L. Our sales excellence program is laser focused on enabling our expanding sales teams with talent, processes, and tools to accelerate our revenue growth and improve effectiveness. Sales effectiveness also supports our move to selling pre-integrated total solutions instead of individual point solutions. This is a key strategic go to market shift and one that can’t be replicated in the market, given our broad and innovative portfolio.

Our organic revenue growth, on a constant currency basis, is steadily improving and expected to be roughly 9% in 2016 at the midpoint of guidance. We have a considerably large runway ahead with roughly 10% market penetration and the industry remains very strong. Giving USA recently published 2015 Giving in the US, which grew $15 billion year over year to 373 billion. We will continue adding sales and customer success headcount in 2016 and improve market coverage by deploying these resources into key markets like Toronto, where we recently opened a new office. And, our partner program introduced in Q1 is also progressing well and currently focused on sales of our financial solutions.

Now let’s move to our third strategy. Expansion of our total addressable market, or TAM. Our approach is to expand TAM through acquisitions or solution expansion into new and near adjacencies. We executed this strategy with the acquisitions of WhippleHill, MicroEdge, and Smart Tuition, adding $1.5 billion in incremental TAM and complementary best in breed cloud solutions to our portfolio. We remain active in the evaluation of acquisitions and solution expansion opportunities that would complement our cloud portfolio, accelerate revenue growth, be accretive to margins, and expand our total addressable market. Our fourth strategy is to focus on streamlining operations. We’ve largely completed the consolidation and upgrade of our back office by moving from over 30 disparate software platforms that ran the major operations of the business to less than 10 best in breed cloud solutions today.

The efficiency gains are significant and our scalable infrastructure prepares us for further organic business growth and the integration of future acquisitions. We will continue our work to optimize these recent infrastructure investments throughout the remainder of 2016 and into next year.

Our final initiative is the execution of an operating margin improvement plan. Our long-term aspirational goal calls for an annual operating margin of 20.5% to 23.5% at 2014 constant currency by the time we exit 2017. This is a 300 to 600 basis point improvement from our baseline of 17.5%, which was the midpoint of our original 2014 guidance. We ended 2015 with 160 basis points of margin improvement over our 17.5% baseline on a constant currency basis. In 2016, we anticipate additional incremental improvement by delivering a full year operating margin of roughly 20% when normalized for currency. Overall, I am very pleased with our progress in the quarter. Execution against our five-point growth strategy is resulting in solid financial performance. We’re widening the gap between Blackbaud and the competition, ultimately delivering greater value for our customers.

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

Tony Boor

Thanks, Mike. Good morning, everyone. Pleased to report that we had a solid second quarter. I will direct you to yesterday’s press release and the supplemental materials posted to our investor relations website for the full detail of our financial performance. I will focus on key highlights today so we can get to your questions.

Our second-quarter revenue was $182 million, an increase of 14.7% over 2015, or 9.4% on an organic basis. We are well-positioned to achieve our full year revenue guidance, anticipate increasing organic revenue growth for the third consecutive year, and are tracking towards the high end of our long term aspirational revenue goal range of 6% to 10% growth annually. Recurring revenue represented 78.7% of total revenue, which is 250 basis points higher than Q2 of 2015 and grew 11.5% on an organic basis.

The growth in our recurring revenue continues to be fueled by subscriptions revenue, which accounted for 58.1% of total revenue in Q2. This is a 690 basis point improvement over Q2 of 2015 and subscription revenue growth of 18.9% on an organic basis. The growth in subscription revenue is a result of our strong and balanced performance across the cloud portfolio and migration of our midmarket customers to NXT. I will point out that our maintenance revenue increased sequentially from Q1 to Q2, despite the fact that we continued NXT migrations. The increase was largely due to the Canadian dollar strengthening against the US dollar from Q1 to Q2.

Turning to profitability, our gross margin was 60%, which is a 60 basis point improvement over Q2 of 2015. We generated operating income of $34.8 million, representing an operating margin of 19.1% and diluted earnings per share of $0.46. As Mike mentioned, we are actively adding sales and customer success heads, which increased sales and marketing as a percentage of revenue, resulting in a lower operating margin versus last year. These results are tracking right in line with our plan and, thus, we are reiterating our full-year operating margin guidance. Our operating margin, adjusted for 2014 constant currency, was 19.6%, which positions us well to achieve our long term aspirational margin improvement goal of 20.5% to 23.5% by the time we exit 2017.

Moving to the cash flow statement and balance sheet. Our Q2 cash flow from operations was 37.9 million, a decline of 5.5 million when compared to Q2 of 2015. The decline is attributable to working capital and relates to our acquisition of Smart Tuition. We didn’t own Smart in the second quarter of last year and Q2 is a seasonal peak for Smart’s receivables, given collections don’t typically occur until the school year begins.

Looking at the full year, as Mike mentioned, we are making an update to our operating cash flow guidance. We’ve taken down the midpoint by $10 million with a revised guidance range of $135 million to $145 million. There are two primary drivers at play requiring the reduction in guidance.

The first is a revision to our estimated cash tax impact of stock appreciation rights and stock performance units for the full year. The second accounts for a change in bonus timing, moving our enterprise business unit from a semiannual to quarterly convention, aligning all business units on the same cadence. Our ability to generate cash remains strong and the revised operating cash flow guidance represents 22% growth over 2015 at the midpoint of guidance. We also remain confident in our long-term aspirational goal of 500 million to 550 million in aggregate cash flow from operations by the time we end 2017.

In Q2, we continued making necessary innovation and infrastructure investments to support our move to the cloud, amounting to 4.7 million in CapEx for property and equipment and 6.4 million for capitalized software development. We also paid out 5.7 million in cash dividends to shareholders and ended the quarter at 388 million in net debt. Our capital strategy calls for a debt-to-EBITDA ratio of less than 3.5 times and we are currently standing at 2.6 times.

Turning to our full year outlook, our 2016 financial guidance accelerates organic revenue growth, improves profitability, and increases cash flow for the full year when compared to 2015. We’ve carried the momentum from 2015 into 2016 and will once again post strong double-digit growth across each category, inclusive of foreign-currency headwinds, and in the first full year of our midmarket cloud transition to NXT.

We expect total revenue of 725 million to 740 million, operating income of 141 million to 147 million, operating margin of 19.4% to 19.9%, diluted earnings per share of $1.90 to $1.98, and cash flow from operations 135 million to 145 million. Based on the latest foreign currency rates we are estimating a revenue headwind of 2 million to 4 million on the year, which equates to a negative drag of approximately 50 basis points on our organic revenue growth. Our estimated impact to operating income is approximately 1 million to 2 million, resulting in an operating margin drag of roughly 10 basis points for the year.

In summary, continued execution against our strategic plan yields strong Q2 results. We are maintaining a disciplined approach to balanced investments to drive revenue growth with improved profitability and we continue to execute on our capital deployment strategy to maintain a strong balance sheet, return capital to shareholders, and create growth and scalability.

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

Question-and-Answer Session

Operator

[Operator Instructions] We will take our first question from Steve Ashley with Robert W. Baird & Company.

Steve Ashley

I was going to ask about the competitive landscape out there, a little bit of noise in the market regarding Salesforce.com in their initiative, which is not new. But could you just bring us up-to-date on if you are seeing any change in their visibility or the competitive landscape in general? Thanks.

Mike Gianoni

Sure, is this Steve?

Steve Ashley

It is.

Mike Gianoni

Steve Ashley, good morning; it’s Mike. There’s been no change in the competitive landscape and we don’t compete with Salesforce.com. We compete with Salesforce.org, which is their foundation arm, so we are not competing with the Salesforce, the software company you know. But it’s a related entity and they are essentially a reseller. In fact, we have multiple competitors and they are a bit different by market. For example, the Salesforce Foundation, we do not compete with them in all of our sub verticals, just a couple of sub verticals. And we have other smaller companies that you may have not even heard of because they are small, private, sort of single-point solution software providers that we compete with in different spaces, like K-12 or others. So the landscape hasn’t changed. We feel really good about how we are positioned. Our newer cloud solutions are being adopted quite well. We feel good about that momentum. And you can see we are investing more in sales, quota-carrying sales folks out in the field and customer success to continue to ramp that up and drive that forward, given our new solutions in the market. And that really is in line with our second strategy of driving sales effectiveness.

Steve Ashley

Then Tony, I don’t, do you have any quantification on the cash flow impact from either the cash taxes or the bonus change?

Tony Boor

Steve, I’d want to clarify a little bit on my prepared comments on the cash taxes. It is an interesting accounting treatment that as soon as we adopt the new rules that just came out on the cash flow presentation it’s going to change. So, effectively, taxes we are paying regarding withholding on behalf of our employees, so it’s not a true cash tax impact to us. What happens is when employees net share settle, when they exercise their SARs or vest on their PRSUs or RSUs, we end up taking out treasury shares and recording that as a debit on the balance sheet. And that debit currently and historically for us, very conservatively I would mention, has been recorded within operating cash flow, which reduces operating cash flow and free cash flow. With the new rules when they come out, which we’re looking at the impact and would expect to early adopt yet this year, that will be required to move down to the financing section, so our operating cash flows will increase as will free cash flow on that side of it. That’s the largest impact on the change in our cash flow guidance and then the bonus would be the smaller component of that moving from a twice a year to a quarterly to get all of the business units in conforming.

Operator

We will take our next question from Tom Roderick from Stifel Nicolaus.

Tom Roderick

Tom Roderick, Stifel. I guess if I look at the big picture here, your stock recently hit an all-time high; expectations are sort of ramping up for what you guys are doing in this transition. And, of course, those sorts of things can take longer than expected, but seems like you’re right on track to hitting the high end of this range. So I guess the question is, as you look at where we go from here, 9.9% growth on a constant currency basis, almost 19% on a subscription basis, what’s it going to take to sustainably kind of punch through that 10% organic growth rate which you guys have laid out as the ceiling of the growth rate on your long term plan for the last few years? And to that point, what are you doing to impact the organization so that you could potentially, sustainably hold a growth rate above that level? Thanks.

Mike Gianoni

Sure, this is Mike. First of all, we are confident on our guidance for this year. We feel like we’ve had a really good start to the year, having finished the first half. As you know, we are in a pretty aggressive operating mode, mostly in our midmarket products, for NXT. We just finished the first year of being live on as Raiser’s Edge NXT and Financial Edge NXT, if you recall, went live in the early fall of last year so we haven’t even lapped that yet. So it’s fairly early days with those midmarket products and we feel pretty confident in our ability to continue to deliver.

What’s really cool is the pace of innovation has dramatically increased given the new architecture. We are able to put new features in production in most of our platforms, sometimes weekly, and so our ability to innovate and have a high velocity engineering environment is significantly different in the last 18 months. So we feel really good about that. And as you know, we have a big focus on sales effectiveness, growing the sales channel, and really focusing more on particular verticals as we move across this industry, including adding to customer success, which really is about maintaining and driving retention rates, which still remain in the 93, 94 percentile, which is great. And that’s inclusive of all of our legacy products. So I would say, in general, we are solid on how we feel so far this year on guidance for the year. We are performing well on those aspirational goals which we’re almost two years into. We announced those in fall of 2014 and the transition that we have kicked off a couple of years ago is operating quite well. So we are feeling pretty positive on year to date results and what the rest of the year is looking like.

Tom Roderick

Great. Good, okay. Looking at some of the investments you made in the quarter, pretty plain to see that you’ve made some big investments in sales and marketing. Now you did have Smart, which fills in for a whole quarter, but that was done at the end of last year. So if I look at sales and marketing, sequentially up over $3.5 million, how would you encourage us to think about that piece of investment going forward? Was there some front end hiring to sales that you were able to put online that we’ll get a little bit more leverage from in the second half? I know you guys don’t guide quarterly, but maybe you can set expectations for just alignment around operating expenses from this current level as we look in the next few quarters?

Mike Gianoni

Sure. Yes, we did invest there. You can see that clearly. We plan on continuing to invest there.

It is more quota carrying sales and customer success than marketing and it really is just the continued build out of the sales effectiveness strategy that we have and customer success. We feel that there is a big opportunity to continue to add quota carrying account executives across the verticals and across the Company and sort of strategically add customer success folks, which has kind of a dual effect. Customer success folks have a big impact on clients being successful with our solutions. We have just this rich history and knowledge of the industry and best practices that our customers benefit from having these kinds of relationships. Financially it drives retention. There’s an intended consequence, if you will, in that it frees up quota carrying account executives to sell and to not have to spend time with existing clients unless there’s a selling opportunity. And so that partnership is building and is critically and we will continue to invest in those areas.

Tony Boor

Tom, this is Tony. As far as impact on the year, I would just suggest that you look back at our guidance that we reiterated on a revenue and a profitability perspective, because all of this ramp in sales and marketing was contemplated in our plan and in our guidance for the year.

Operator

And we will take our new question from Brad Sills, Bank of America Merrill Lynch.

Brad Sills

Just a question on reporting. Just wanted to get your thoughts on where you are seeing some traction there. You mentioned the launch of SKY Reporting. Are there any product suites or use cases that you are seeing traction? And then any examples of potential price uplift that you’ve seen already with some of the accounts you’ve signed for SKY Reporting?

Mike Gianoni

Brad, this is Mike. That platform is a part of the overall SKY architecture. And what’s significant about that is it’s a world-class business intelligence and reporting engine that will replace the BI reporting engines and has already in Raiser’s Edge NXT, but it’s a common reporting engine that is product agnostic. It is quite unique in the industry because, if you look at our products or you look at the competition and what is installed out there, every solution has their own reporting engine. So because we have this common reporting engine now, starting with RE NXT, it will aggregate data from multiple Blackbaud products.

And so we showed a couple of weeks ago at our K-12 user conference we showed some management dashboards, all graphical, and some reports, that are all manual today for that set of customers. And so the value proposition is significant. A solution like this doesn’t exist today in the market and it’s just one of the components of the SKY architecture. So big impact for customers starting off on Raiser’s Edge NXT, going across eventually the whole portfolio with the SKY architecture.

Brad Sills

Got it, got it. Is it opening up your addressable market to new users, both in financial and reporting? Are you seeing that?

Mike Gianoni

What it’s opening up is it’s opening up this integrated approach that we keep talking about that SKY has created. Sort of the first instance of the SKY architecture was common user experience across multiple products, which Raiser’s Edge NXT sort of manifests itself quite well. This opens up common reporting across multiple products, so the ability to aggregate data in a product agnostic way is something brand new for the industry. And what happens is there’s a lot of manual processes that happen today where customers print reports and look at reports from two, three, four, five different systems to try to put things together either in a manual way or they go implement a third party reporting engine to try to aggregate data to solve that problem for them. And no one in the industry is doing this in a way that we are.


Q - Brad Sills

Great, thanks. Then one more, if I may, on NXT. With customers where you’ve seen the migration from on-premise to NXT, I know with the user interface you’re now getting at features and functionality that’s more applicable to the business user as opposed to the back office and the database administrator, for example. Are you seen with customers that have done the migration that you are getting that uplift in user base going after a wider user base in some of the existing accounts?


A - Mike Gianoni

Yes, we are. There are more users using the system than in the previous Raiser’s Edge 7. Our pricing model sort of facilitates that with Raiser’s Edge NXT. And we are also seeing some pretty interesting improvements in our nonprofit customers’ operations. We have case after case of their revenue going up; their operating expenses going down. They are getting pretty quick ROIs and so the value prop is clearly there. Forrester just did a study in one of our customers. They got a pretty fast ROI on moving to RE NXT that we, of course, have the report to share with existing and prospective customers. And so the impact to our customers is quite significant on their operations, which is a win-win for both of us.


Operator

We will take our next question from Justin Furby with William Blair.


Q - Justin Furby

Just a couple of quick questions. Mike, first for you on bookings. We don’t really get disclosures there, but could you give us a sense in terms of how you guys did in Q2 versus Q1 and versus your expectations going into the quarter? Then any sense for mix of bookings in terms of new customers versus just on-premise migrations to NXT? Are we at a point where we’ve doubled that 1,500 NXT customers or any sort of commentary there? Then I’ve got one quick follow-up for Tony, thanks.


A - Mike Gianoni

Justin, we don’t break that out, but I will give you some themes here. We are very pleased with our year-to-date bookings across the entire quota-carrying sales teams, such that we continue to add headcount. We add headcount because of our view to future expansion and future opportunities on top of some pretty good success. And it’s starting to show itself up in organic revenue growth, so we’re pretty happy with that. The mix is pretty strong. We do have teams that are dedicated solely to net new Blackbaud-named customers, which is important to understand. In any software business it’s a little more difficult to get net new customers than to sell an existing customer your new solutions. And so we want to make sure that we have folks that are dedicated to net new and going after that business and not being distracted and just going after upgrades. Not that it’s a distraction, because we’re doing well there, but you understand we want specific focus on net new. And we continue to add headcount to both, back-to-base and net new. The product mix is pretty strong. We’re talking a lot about NXT, but we are not an NXT only story, and so the product mix across the portfolio remains strong. It includes our acquired businesses: MicroEdge and WhippleHill in K-12, MicroEdge and foundations in Smart.

Those are doing well organically; we’re executing well with those and our core fundraising portfolio, in addition to RE and FE NXT. Our online digital omnichannel marketing platforms as well. We feel pretty good about growth in the portfolio, sales mix growth, net new and back-to-base sales.

Justin Furby

Got it, that’s helpful. Then for Tony, just a two-part question. It seems like subscription revenue growth has, 19% the last couple of quarters. Curious, if you look out to the back half of the year, are we at a point where we sort of plateaued there and you expect us to downtick? Do you expect it to maintain or could it even accelerate further in the second half? Then I wanted to clarify on the casual guidance. I thought what I heard you say was you are going to be adopting the new FASB conventions as an early adopter this year. So wouldn’t that make this whole incremental tax component a moot point when you reclassify that back up to operating cash flows? Thanks.

Tony Boor

Justin, on the subs growth, as Mike said, we feel really good about where we are with the adoption of the new strategies and new products. I think the thing I would tell you on subs growth is we don’t break out obviously in any more granularity, but there’s quite a bit of seasonality from the payments business and the usage business. And then also some incremental seasonality now with like the addition of Smart Tuition late last year. They’re going to have more seasonality around the start and first part of the school year, so we’ve put a little more seasonality into the late Q2/Q3 timeframe. So we will just have to, because we don’t give that granularity I can’t provide that today, but I would tell you just watch for some of that seasonality that we’d typically see in the giving seasons for the payments and usage side of the business. And then we will have some incremental seasonality in Q3, I would expect, because of the Smart Tuition add to the team.

On the cash guidance, you’re correct. Interesting point in time we are because we have not adopted, early adopted the guidance. And you have to, when you look at those new rules, there are several different components that have to all be adopted at the same time to early adopt. And so we are just evaluating the impact of all of those. There are several elections and changes in accounting for forfeitures, with your stock comp plans, and several other things that we are making sure we evaluate fully before we determine to early adopt. Assuming we early adopt, I would say, as I said earlier in one of the questions, we have historically taken a very conservative approach and pushed the withholding amount on net share settlements through the operating cash flow section. I think most companies, it’s hard to see what peers are doing, but I believe most companies are running that through financing activities. So when we move that out we will see a positive improvement in operating cash flows. That, again, is a non-income net income impacting item, so it will be a positive result. The problem is I haven’t implemented that and I can’t be for certain that we will have really adoption, because we’re still evaluating it at this time; hence, we had to change the cash flow guidance.

Operator

We will take our next question from Ben McFadden with Pacific Crest.

Ben McFadden

I will start with just kind of the subscription revenue growth. I think on a sequential basis it was a little bit lower than what we’ve seen in the last couple of years, but the deferred revenue growth was actually higher sequentially than what we’ve seen the last couple years. So was this a function of what you were just talking about around seasonality or was there a backend weighted aspect to the quarter? Any color that you can provide there would be great.

Tony Boor

Seasonality certainly being a big piece of that, Ben, and then I think also you’d have to look at -- when you look at a comparative period you’ll have to keep in mind all the acquisitions we did in the prior two years, the timing of those. You would’ve gotten a spike in deferreds post close on those transactions as well. So overall we feel really good about the trend in that line with where we are. I don’t know that there’s a lot else I can add other than what I just went through, Justin, on the seasonality and the impact of the acquisitions.

Ben McFadden

Then just from a quarterly basis, I know you don’t guide on a quarter basis, but just broader picture, as we think about operating margins, they have historically been higher in Q3 and I know you have your conference in Q4. Is there -- directionally is there any way we should be thinking about how operating margins should ramp throughout the rest of the year? Should we still expect Q3 to be a much larger number than Q4?

Tony Boor

The only thing I can refer you to there, just like I did with Tom, is I’d just look to our full-year guidance and our actual performance year to date and then you can triangulate in. Since we don’t give quarterly it’s really difficult for me to go into a discussion on Q3 versus Q4, but you’ll certainly have a good sense of what the second half should be in totality.

Operator

We will take our next question from Kevin Liu with B. Riley

Kevin Liu

You mentioned Attentive.ly was already integrated with Luminate online. I’m just curious if that’s added on as just a feature for customers that adopt the Luminate platform or if it’s expected to be sold as either a standalone module or maybe an additional feature.

Mike Gianoni

It’s kind of both. I would call it lightly integrated, Kevin. This is Mike, by the way. So what we are going to do is we’re going to deeply integrate it in a way that it’s a lot more frictionless, if you will, and just shows up as a part of Luminate next-gen. It will also be used on other platforms as well. The first will be Luminate next-gen. We do share quite a few customers today that are very successful and so that really was a move to just accelerate our ability to add that functionality to the portfolio starting with Luminate next-gen.

Kevin Liu

Got it. And just with respect to the pace of sales, in the past you guys have talked about, if you continue to see strong organic growth, you’d be willing to invest aggressively and that would perhaps push you towards the lower end of your long-term margin targets. Are you guys at that point already where you’ve made that determination and you are stepping on the gas for sales hires? Or are you still kind of evaluating the appropriate pace at which to invest going forward?

Mike Gianoni

I would say it’s balanced, Kevin. I wouldn’t call it stepping on the gas, but if you recall back in the fall on our five-point strategy, I added sales effectiveness as point number two. And so we have in the last year much more formalized sales operations, go to market, and our thinking and planning around this ramp up in quota carrying sales and customer success. I put that in the same vein, if you will, from a project standpoint. So I would say that we are more aggressive. I don’t know that stepping on the gas is the right way to put it, but we are being more aggressive. And it’s all timed right. So if you go back a couple of years and you look at what we’ve done in engineering and innovation and product management and our ability to bring new solutions to market in capabilities like SKY that energize the whole portfolio, sales effectiveness is timed a little after that because we are now more ready to be a bit more aggressive in that regard, if that makes sense.


Operator

We will take our next question from John Rizzuto with SunTrust.


Q - John Rizzuto

A couple questions around products and what you’ve been talking about here, Mike, and longer-term strategy, which also plays into sales effectiveness. You have a broad portfolio, a lot of solutions. Really target functionality solutions, targeted at different verticals within the markets that you play. Many targeted at different size organizations, so it’s a pretty broad product portfolio. Do you see or are there plans to kind of, as you progress forward, start rationalizing this more, getting it into a more integrated platform of sorts? Is that possible; is that feasible? Or just any thoughts around that.

Mike Gianoni

That is what’s been going on actually, John. If you recall in our investor presentation that we use at conferences, there’s one page in there about halfway through the deck that is a one-pager on all of our solutions. And that’s the core portfolio of the Company. There are solutions that we have that are not on that page that are legacy products that we are aggressively moving customers to our new cloud solutions. So that one page is the rationalization of the portfolio and it’s not that large and complex. I think the perception is it’s large and complex, but given the size of our company, we have rationalized that. We have legacy platforms we’re moving customers off of, but that one pager has pretty much the go forward products in the Company.

John Rizzuto

So that is really what we want to, okay, I’m familiar with page. That’s what we want to focus on is that and over time watching that evolve. So of course part of this strategy is an ecosystem with going to the cloud, getting people to develop for the cloud, getting your products leveraged more broadly. Can you just comment on how the ecosystem is growing for this so far?

Mike Gianoni

Sure. We’ve signed up a couple hundred partners in the last few years. We’ve revamped our partner program a few years ago. We have partners actively now using SKY API. For example several partners in that program. We also have partners using our SKY UX development toolkit to build new products that have the look and feel of our core solutions. And as you recall, we signed up some VARs as well, mostly focused on our financial platform, FE NXT, which is sort of early days for us in that, because it’s not a program that has been around longer than the first half of this year. So the network is expanding; the interest is significantly higher because we have open sourced some of our tools. You can find them in GitHub and, from a partner standpoint, it’s a pretty significant, growing interest in our space and the new technology and new capabilities make it such.

We also have a growing partnership with Microsoft, you probably read a little bit about that, our use of Azure. In our K-12 conference a couple weeks ago, we announced another partnership with Microsoft’s U.S. education business unit where we have integrated with OneNote, one of their solutions that is a complementary solution in our K-12 space. It sort of fills in an area that we don’t have and, likewise, for them. And so that partnership continues to grow and flourish as well. In fact, we were, interesting enough, we highlighted, Blackbaud in one of our customers, was highlighted at the worldwide Microsoft partner conference in Toronto a couple of weeks ago as one of the key partners. So a lot going on in the partner area and from an ecosystem standpoint and the new SKY architecture really facilitates that.

John Rizzuto

Fantastic. Going forward, the product portfolio is basically going to be sold by, across the board by your sales execs. Just vertical breakdowns that your thinking with and with products breakdown, what is that ultimately going to, what are you thinking about it looks like as you build out this new sales force? Anything you can give us around that.

Mike Gianoni

Sure, John. We are highly direct today. I don’t see that changing significantly. We’ve sort of dipped our toe in the water, if you will, on VARs on a particular product because we think we can accelerate our ability to go to market with that product in a broader way. These are VARs that have experience in like products in the nonprofit space and so we are leveraging their distribution channel. I don’t believe a VAR channel will go across our whole portfolio. We will largely remain direct and, yes, we are focused on sub verticals. We find that having our account executives in sub verticals, like, K-12 is just one example because we’ve been talking about that a bit today. It is very much a value-added way to go to market. Given the fact that we have deep knowledge and capabilities in the space, it’s a better way to go to market and so these are. In these sub verticals, although they have some like requirements in fundraising, now they are quite a bit different. If you go into arts and cultural, things like ticketing and reserve seating are important in addition to fundraising, which those things don’t exist in other sub verticals as an example.

Operator

We will take our next question from Ryan MacDonald with Wunderlich Securities

Ryan MacDonald

Can you start by talking about, last quarter you provide an update on the adoption or the number of customers that you had kind of migrated over to SKY UX. I think it was around 7,000 customers. Can you talk about what kind of progress you’ve made there in second quarter and if you can quantify how many customers now have transitioned over to that?

Mike Gianoni

So we don’t break that out by quarter and, in fact, we have over 10,000 customers logging on every day with the SKY UX experience, if you will. And that includes over six products and Raiser’s Edge NXT is just one of those six.

So what’s really great about the progress here, Ryan, is we announced the SKY UX and SKY API and SKY architecture just last fall at our client conference. We had used that architecture and set of capabilities and tools to bring RE to NXT and to the cloud and FE or Raiser’s Edge and Financial Edge, and now we’re moving the capabilities across the whole product portfolio. And so from the announcement last fall to today, over 10,000 customers and six products in production. But for example, our entry level CRM platform, eTapestry, all of those users one Monday morning logged in and it was SKY UX. And so those set of capabilities are moving across the entire portfolio. The next really big push will be the Luminate next-gen project underway. SKY UX will be adopted and deployed there. And that’s on the front end, the SKY UX. On the back end we have things like common email engine and SKY Reporting, which I talked about earlier, is sort of on the backend in that architecture. It’s moving across the whole portfolio.

Ryan MacDonald

Then moving to the sales and marketing headcount that you added during the quarter, are there increased investments that you’re making there? Can you give us any sense of what type of timeframe it takes to ramp those new sales heads? And then what say, from a geographic perspective, if there was any focus on the headcount adds there as you look to kind of continue to expand the business there?

Mike Gianoni

Sure. Geographically, it’s sort of North America wide. We focused on the big cities where most of the customers are and we have offices already in all of those locations. We opened a new office in Toronto; you might’ve read about that. We have a nice book of business in Toronto, all served historically from the U.S. So we have a presence up there now locally, which is beneficial. It really was the only geographic location where we needed a new office. We are in all the other locations, so that’s sort of one point.

Secondly, we are hiring across North America in those offices and areas to be closer to our customers. We are adding both sort of inside sales and outside field sales as well and customer success. Time to ramp is different by type. If you are a new account executive in our enterprise business unit, those are longer sales cycles. They’re much larger, typically multi-million-dollar, deals. It takes a bit longer to ramp up, if you will, because of the sales cycle; all the way to the other end of the spectrum. If you are in-house mostly or all-on-the-phone salesperson selling our lower-end solutions, the ramp is quite quickly, a couple of months. And so there’s a pretty wide gap based on the type and we are hiring all types.

Tony Boor

Then the customer success, Ryan, you’ll see that is a longer-term play, because that’s typically going to come through as improved customer satisfaction and retention. So I’d assume the impacts of those investments are probably a year to two years out.

Mike Gianoni

Right. I’ll add one note on retention. Tony and I talk about this a lot -- is that many of our clients still only have one of our solutions. We have looked at clients that have adopted things like payments and analytics and those clients go from the low 90%s to the high 90%s in retention rates. And so we continue to cross-sell into the base, even into our legacy RE 7 customers. We cross-sell into the base if they are not quite ready to go to NXT. It drives retention; it drives value prop for the customer and increased recurring revenue for us and higher retention. Again, I will also add that the customer success adds are going a long way into adding, to freeing up productivity of quota carrying sales folks as well.

Operator


We will take our next question from Kirk Materne at Evercore ISI.

Patrick Falzon

This is Patrick Falzon on for Kirk Materne at Evercore ISI. Congrats on the quarter, guys. Can you just provide any color around the higher ed solution you all launched during the quarter and how big of a market is this addressing for you?

Mike Gianoni

It’s a set of solutions and a set of services that we launched in higher ed several months ago and it really is to help the higher ed institutions really think about sort of next-gen world-class fundraising platforms. We have, in that market is again a little bit different, like I talked about earlier; I compared a couple of sub verticals. In higher ed they do things like capital campaigns to build buildings and so that’s quite different than if you are in a different vertical, like an arts and cultural. Potentially, they might do that once. So these are usually larger, much larger investments and the solutions we provide at the core are either Raiser’s Edge NXT or our enterprise CRM for the largest institutions. That offering was a set of products and services to help higher education institutions think about their future and make a move toward our best-in-class platform. And we did that to really focus on the largest institutions globally.

Operator

And we will take our final question from Tom Roderick.

Tom Roderick

Quick follow-up. A lot of talk here more recently about your K-12 division just given the integration of WhippleHill and Smart. So as you’re getting more questions about that, curious if you can help us put some parameters around that business just in terms of what the general scale of it looks like at this point. And maybe more pertinently, what are you doing to affect cross-sales between that division and the core product set? And how is the sales organization structured there these days?


A - Mike Gianoni

You bet. We significantly increased our TAM, as you recall, in K-12 with the WhippleHill acquisition, which is two years ago now of June, and then Smart Tuition. What’s really interesting about that space is we provide a set of solutions that are unique in the marketplace. We do that in all of our markets. In fundraising, in that space we are a bit wiser because of the WhippleHill solutions and the fact that we run the schools, do tuition management, and have the NXT platforms for financials and fundraising. It’s just a whole different model. So we are, in a lot of cases, displacing six, seven, eight point solutions with our integrated platform and we have integrated those platforms together now, so it’s quite a unique value proposition. It’s a big market. From a go-to-market, Tom, we have a dedicated sales team. All they do is call on K-12 schools. There’s over 20,000 addressable schools. We did not have a lot of overlap between the Smart Tuition management and "on" products which we acquired two years ago from WhippleHill. So there’s cross-selling going on in there and then there’s full-package solution selling.

That K-12 sales team sells all of our solutions to the K-12 market, so we do not need to bring in other sales teams to, say, sell RE NXT, for example, or Financial Edge NXT and the WhippleHill. That one team sells all solutions to that marketplace. So we have a great advantage where we cover a lot of the solution needs in the market. We drive the relationships that we have across the market and reference ability. And if you recall, when we made the acquisition, we combined the selling teams of WhippleHill to the sales teams of Blackbaud back a couple of years ago now and we have significantly grown that team. So they are able to go in and cross sell. They are able to go in and sell the full suite as well.

Operator

That does conclude today’s Q&A session. I would now like to turn the conference back over to management for any additional or closing remarks.

Mike Gianoni

Thanks, operator. It looks like we’re out of time. I will just close by saying that Q2 was a solid quarter for us. I will remind folks that we have our investor day on October 27, combining it with our bbcon customer conference. We look forward to seeing you all there and reporting against our progress year-to-date at that time. Thanks, everyone.

Operator

This does conclude today’s conference call. Thank you all for your participation. You may now disconnect.

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