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Blackboard, Inc. (NASDAQ:BBBB)

Q3 2007 Earnings Call

November 1, 2007 4:30 pm ET

Executives

Michael Stanton - Vice President ofInvestor Relations

Michael Chasen - President andChief Executive Officer

Mike Beach - Chief FinancialOfficer

Analysts

Tom Roderick - Thomas WeiselPartners

Amy Junker - Robert W. Baird

Kash Rangan - Merrill Lynch

Trace Urdan - Signal Hill

Michael Nemeroff - Wedbush

Trey Kuppin - Banc of AmericaSecurities

Operator

Welcome to the third quarter 2007Blackboard Incorporated earnings conference call.  [Operator Instructions] I would now like toturn the call over to Mr. Michael Stanton, Vice President of InvestorRelations.  Please proceed sir.

Michael Stanton

Thank you, and thanks everyone forjoining us.  I'm just going to actuallytake a quick second; my understanding is that our conference vendor is having alittle bit of difficulty patching people into the call.  So I want to apologize for that, I'm notcertain what the technical issues is, but certainly we apologize for any delaythat people experience getting into the call.

Per usual, I'd like to remindeveryone that except for historical information presented, the matters discussedtoday may contain forward looking statements under the Safe Harbor provision of the PrivateSecurities Litigation Reform Act of 1995. Such statements are based upon management's current expectations and aresubject to a number of risks and uncertainties that could cause actualperformance and results to differ materially from those discussed in theforward looking statements.  Among theimportant factors that could cause actual results to differ materially from thoseindicated by such forward looking statements are delays in product development,undetected softwares, competitive pressures, technical difficulties, marketacceptance, availability of technical personnel, changes in clientrequirements, risks of international operations, general economic conditions,and such other risks as described in the risk factor section of Blackboard'smost recent Form 10-Q on file with the SEC.

Blackboard undertakes no obligationto 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 ofthese metrics we will provide today.  First, we will provide non-GAAP adjusted netincome and non-GAAP adjusted net income per share on this call as additionalinformation regarding our operating results. The measures are not in accordance with, nor an alternative for GAAP andmay be different from other non-GAAP measures used by other companies.  Blackboard believes that the presentation ofthese non-GAAP financial measures provides useful information regardingadditional financial and business trends relating to the Company's financialcondition and results of operations.  Areconciliation of GAAP and non-GAAP metrics has been provided in today'searnings press release.

The second administrative notesrelates to our contract value, which we will also provide today.  Our contract value represents the annualizedrecurring ratable revenue under existing contracts with clients in effect atthe end of the quarter without regard to the remaining duration or renewal ofsuch agreements.  This is not intended bymanagement for the estimation of, or as a proxy for future revenue to berecognized, but management believes it is a useful tool for investors toevaluate our current operating performance.

Finally, I have once again providedsupplemental information related to licenses, contract value on the investor centersection of our website at investor.blackboard.com, the document is titled,"Q3 2007 Blackboard Metrics."

On today's call are Michael Chasen,President and CEO, Mike Beach, our Chief Financial Officer.

At this time, I'd like to turn itover to Michael Chasen. Michael.

Michael Chasen

Thanks, Michael.  Good afternoon everyone.  Let me start with an overview of the agendafor today's call.  First, we'll give youa summary of our performance for the quarter ended September 30, 2007.

I will cover our operationalhighlights in the third and some of the dynamics we are experiencing in theindustry.  I will also discuss ourinitial thoughts on some planned investments given the growth opportunities wesee ahead.  I will then turn the callover to our CFO, Michael Beach, to take us through a more detailed review ofthe financials and guidance.  Finally, wewill close with your questions at the end of the call.

Among the financial highlights inthe third quarter, we increased revenue year over year by 22% to $61.6 millionand generated net income of $3.3 million and earnings per diluted share of$0.11.  We had $6.6 million in non-GAAPadjusted net income and non-GAAP adjusted net income per share of $0.22.  All of these results are ahead of expectationand put us on track for another great year.

As a reminder, Blackboard'sbusiness model is primarily driven by, first, our ability to renew our largesubscriber base of clients, which provides a great operating leverage inherentin our business.  Second, our ability toexpand our existing client relationships, growing their subscription value overtime by addressing more and more of their emerging e-learning needs.  And third, our ability to add new clientsubscribers across the education spectrum here in the United States and around the world.

This quarter we expanded ourexisting relationships and established new ones with a wide range of differentinstitutions.  A few examples of deals inthe US highereducation market include Brigham Young University and the University of Pittsburgh.  Each licensed the Blackboard Content Systemduring the third quarter to more effectively manage and share their academicresources across their respective campuses.

In our Commerce business, we arepleased to welcome Kentucky State University and Hamilton College as new clients.  Both schools licensed the BlackboardTransaction System.  Additionally, wealso had substantial expansion commerce sales with UCLA, Temple University, and Ducane University, all of which expandedtheir relationship with us by moving to the Blackboard Transaction SystemUniversal Edition.

Other academic suite expansionsales in the quarter included Howard University,North Harris Montgomery Community College District, Malone College and Rio Hondo College,all of which adopted our ASP hosting offering. And finally, the Southeastern Baptist Theological Seminary was our firstformer WebCT client to adopt a Blackboard Community System which they will useto better communicate and interact with their student and faculty members.

On the international front, in England,the City of Wolverhampton College licensed the Blackboard Learning System andis also using our ASP hosting service.  In Turkey,Kadir Has University with 2,000 students, and Istanbul Bilgi Universitywith 10,000 students, each licensed our Blackboard Learning System, theBlackboard Community System, and the Blackboard Content System products.  Both schools also opted for our ASP Hostingoffering service. 

Lastly, the Estonian IT Foundation,the legal body of the Estonian e-learning Development Centre has adopted the BlackboardLearning System Vista Edition for all universities and vocational and secondaryschools in the county.  The goal of theprogram is to establish high quality, flexible, and internationally competitivehigher and vocational education that is available to various target groups in Estonia. 

In K-12, I would like to highlighta couple of deals, including New Orleans Public Schools, which upgraded fromthe basic Blackboard Learning System to our Enterprise Version.  In addition to the license upgrade, New Orleans also contracted with us for our ASP Hostingoffering.  This was a great expansionsale for us in quarter.

Similarly, the South CarolinaDepartment of Education has also decided to transition their BlackboardLearning System license to our ASP Hosting facility.  In moving to Hosting, South Carolinaadministrators can now better focus their attention on building online contentand marketing those materials to the K-12 districts throughout the state usingBlackboard solutions.  Again, these are justa few of the client examples from the third quarter, but they arerepresentative of the traction we are seeing in our business so far in 2007.

Moving on to licenses, we ended thethird quarter with a total of 3,797 Enterprisecategory licenses.  Breaking up theselicenses, we had 2,255 licenses of the Blackboard Learning System Enterprise,700 licenses of the Blackboard Community System, 354 licenses of the BlackboardContent System, 28 licenses of the Blackboard Portfolio System, 21 licenses ofthe Blackboard Outcome System, and 439 licenses of the Blackboard TransactionSystem.  In terms of the BlackboardLearning System basic product, we ended the quarter with 1,077 licenses.  The total number of licenses at the end of thethird quarter was 4,874.  We finished thethird quarter with 502 ASP Hosting units.

As for contract value, we finishedthe quarter with an annualized contract value of $184.5 million, representingapproximately 19% growth year over year.  This resulted in average contract value perlicense of approximately $37,850.

As many of you know, Blackboard'sthird quarter represents the peak renewal period for the company during theyear.  In the third quarter, ourretention rate was in line with our historical experience of approximately 90%.  Our total headcount at the end of the thirdquarter was 815 people and was comprised of the following.  We had 184 people in sales of which 70 werequota bearing sales reps, 68 in marketing and business development, 143 in productdevelopment, 148 in support ASP Hosting and production, 129 in professionalservices, and 143 in operations.

In closing, I am excited to discusssome investments we intend to make over the coming year given the growthopportunities we are seeing in our business in the broader market.  As you all know, Blackboard continues to enjoygrowth through new client relationships both domestically and internationallyand in multiple education sub vertical.  Naturally,we will continue to expand our educational sales force into increasedproductivity among sales professionals in penetration in our target markets.

Blackboard's existing client baseprovides us with access to more than 3,400 institutions who continue to shareperspectives on how we can further innovate by integrating technology intoteaching, learning, and academic life throughout their organizations.  We have an ongoing dialog with our communityof users.  We speak with and solicitfeedback from them constantly through our sales support and serviceorganizations at our user conferences and other industry events and via seniorlevel collaboration between our executives and industry thought leaders.  Based on this feedback, we believe that wehave identified a number of attractive opportunities for investments that willnot only enhance the education experience for all of our extended constituents,but will support superior client satisfaction and future growth opportunitiesconsistent with our long term operating objectives.

Over the course of the next year,we will make investments in the key areas that drive overall clientsatisfaction.  Specifically, the threeareas of investment are in product development, client support, and ASPHosting.  First, in product development,we will be funding several different initiatives.  One of the most important investments that weare making is to develop more K-12 specific functionality within the academicsuite products.  This year we have seenan increase in the number and dollar sizes of K-12 RFPs, and believe that wewill soon see more K-20 opportunities in the coming years.  These are very encouraging developments anddemonstrate the evolving maturity of the K-12 institutions and their use of Enterprisetechnology.  In order to meet the growingdemands in this market, we will develop features for both safe standardsalignment and lesson planning.

Integrated learning standardsprovide our K-12 clients with the ability to align their institution with thestandards mandated by their state Department of Education.  Additionally, a lesson-planning tool willempower our K-12 clients to create and maintain standard spaced instructionalmaterial.  By investing more in theseK-12 offerings, we believe that we can better deliver on our vision of lifelongteaching and learning with Blackboard solutions and be in an excellent positionto win the new deals that we are beginning to see in the market.

As for our clients who joined usthrough the WebCT merger, we are taking measures in product development toensure that 100% of these institutions are on a stable release of theBlackboard Learning System products.  Asyou know, we released Application Pack 2 in June of this year, which addressedover 1,500 known issues with the Legacy WebCT code base.  That release went a long way towards resolvingproduct issues and we continue to release service packs to stabilize ourclients.

Going forward, we are committed toidentifying and resolving any other issues that would affect our client'sBlackboard experience.  These investmentswill not only pay near term dividends through client retention, but will alsogreatly enhance our ability to cross sell products to these clients over thenext few years.

One final product developmentinitiative that we will be focusing on in the coming year relates to our BlackboardCommerce Suite offerings.  As I mentionedearlier, we had some tremendous new wins in expansion sales in the quarter andmuch of this is due to some investments we have been making in the past 12months.  We will continue to invest inthe Blackboard Transaction System, particularly in our Universal Editionoffering to meet the evolving student service requirements in the highereducation market.  As part of thiseffort, we will be foregoing new partnerships to incorporate the latesttechnologies into our solutions.

Second, in terms of clientsatisfaction, we recognize the critical importance to our support organizationand the direct correlation this group has to long term client retention. Wehave launched a client experience advisory committee that will work directlywith us on client issues and feedback.  Wewill also be adding additional resources for primary and secondary supportissues over the coming months. Again, by enhancing our support organization, wethink we can substantially improve our client's experiences with Blackboard,which should drive client retention and cross sell opportunities.

Third, and finally, we continue tosee growing opportunity for our ASP hosting business.  Blackboard began offering hosting about sixyears ago with two facilities here in the United States. Last year we launched a hosting facility in Amsterdamand we have seen tremendous uptake from our clients in Europewho depend on us to run their e-learning applications.  Based on these successes, we are planning toexpand our current international facility and open another hosting facility toserve our international clients.  Webelieve that the business environment that has contributed to a healthy ASPperformance domestically is now developing internationally and we want to meetthis robust demand.

In summary, we are encouraged bythe increasing number of opportunities that we see to invest in our existingclient base driving instrumental growth through cross sell, up sell, andenhanced retention opportunities.  As wecontinue to experience enhanced operating leverage due to the scale andreoccurring revenue base, we will look for ways to opportunistically reinvestthose profits, strengthening our competitive positioning and supporting oursustainable growth profile.

Accordingly, while we would haveexpected to see natural margin expansion over the coming year, we would expectthe net impact to be more modest after taking into account reinvestment in theinitiatives I have just described.  Weare confident that the nature of these investments will benefit both ourcustomers and shareholders and that they are consistent with our long term planfor driving growth and profitability.

With that, I'm pleased to hand itover to our CFO, Michael Beach, to cover our financials and future guidance.  Mike.

Mike Beach

Thanks, Michael.  I’ll organize today's financial review aroundthe income statement, the balance sheet, and cash flow, and close with theoutlook and guidance for the fourth quarter and full year of 2007.  Revenues for the third quarter of 2007 were$61.6 million, up 22% from last year.  Productrevenues for the quarter were $54 million, representing an increase of 24% overthe same quarter last year.  Professionalservice revenues for the quarter were $7.6 million, which represents anincrease of 9% over the prior year.  Interms of revenue characterization, we also break out our revenues by the natureof the revenue stream, which include ratable recurring, ratable non-recurring,and other revenues.

For the quarter, ratable recurringrevenues increased 31% to $46 million as compared to $35.3 million in the samequarter last year.  Ratable non-recurringrevenues increased 2% to $5.5 million, as compared to $5.4 million in the samequarter last year.  Other revenuesincreased 3% to $10.1 million as compared to $9.7 million in the same quarterlast year.

Moving on to gross profit, ourgross profit for the third quarter, excluding stock based compensation and theamortization of acquired technologies, was $45.5 million as compared to $34.9million in the same quarter a year ago, representing an increase of 31%.  For the quarter, our gross margin was 74%.

Total operating expenses, excludingthe cost of revenues, stock based compensation, and amortization of acquiredintangibles, were $32.4 million, representing an increase of less than 1% ascompared to $32.3 million in the same quarter last year.

Operating expenses were slightlyhigher than expected in the quarter.  Inparticular, I would like to point out that we experienced higher than expectedcosts in R&D due to professional service expense we incurred supportingongoing product development efforts on the transaction system business

.

Our G&A expenses were alsohigher by approximately $500,000 due primarily to the severance costs wediscussed on the last call and professional services related to a non recurringtax project which has had the direct result of increasing our net operatinglosses by over $4 million which will be available to offset future cash tax liabilities.

For the quarter, we incurred stockbased compensation expense of $3.5 million and intangible amortization expenseof $5.5 million.  

Our net income was $3.3 million,compared to net loss of $4.8 million in the same quarter of last year.   Net income per basic share was $0.11 for thequarter. Adding back the amortization of acquired intangibles and net of theassociate tax impact results in non-GAAP adjusted net income of $6.6 million ornon-GAAP adjusted net income of $0.22 per diluted share.

In terms of balance sheet, weclosed the quarter with $208 million in cash and cash equivalents.  Accounts receivables increased to $65.8million at the end of the quarter from $61.4 million for the same quarter lastyear.

Current deferred revenues increasedto $130.5 million at the end of the third quarter, up 10% from the $118.4million at the end of the third quarter last year.  Current deferred revenues related to recurringproducts, totaled $114.7 million, compared to $101.5 million for the same quarterlast year, representing a 13% increase.

An important reminder here forinvestors, similar to last quarter, our new purchase order policy resulted inapproximately $6.5 million of invoicing shifting from the last few weeks of thethird quarter to the first few weeks of the fourth quarter.  It's important for investors to take thischange into account, when comparing Blackboard's deferred revenues and accountreceivable balances with prior periods.  Forexample, if you add back the $6.5 million to the ending Q3 2007 currentdeferred revenues related to recurring products, year over year growth wouldhave been 19%.

Cash flow provided by operationstotaled $38.4 for the third quarter, which represents a 57% increase comparedto cash flow from operations of $24.5 million for the third quarter of lastyear.  We were pleased with cash flow forthe quarter and are seeing the initial impact of the purchase order system, weimplemented last quarter.  Capitalexpenditures were $4.1 million for the third quarter.

Moving on to guidance, for thefourth quarter of 2007, we expect revenue of $61 to $62 million.  Amortization of acquired intangibles of $5.5million, net income of $4 to $4.5 million, resulting in net income per dilutedshare of $0.13 to $0.15, which is based on an estimated 30.4 million shares andan effective tax rate of 41.5%.  Non-GAAPadjusted net income, which excludes the amortization of acquired intangiblesand the associate tax impact of $7.3 to $7.8 million, resulting in non-GAAPadjusted net income per diluted share of $0.24 to $0.26, based on an estimated30.2 million shares and an effective tax rate of 40.5%.

For the full year 2007, we expectrevenue of $237.3 to $238.3 million. Stock based compensation expense of $12.3 million.  Amortization of acquired intangibles of $22million.  Net income of $12.6 to $13.1million, resulting in net income per diluted share of $0.42 to $0.44 which isbased on an estimated 29.9 million shares and an effective tax rate of 41.5%.  Non-GAAP adjusted net income, which excludesthe amortization of acquired intangibles and the associated tax impact of $25.9to $26.4 million, resulting in non-GAAP adjusted net income per diluted shareof $0.86 to $0.88, based on an estimated 29.9 million shares and an effectivetax rate of 40.5%.

Included in the fourth quarter andfull year guidance is non cash rent expense, which we will begin to incur whenwe are granted access to our new headquarter space for the purpose ofconstruction.  We will not have cash rentrelated to this lease until late in the second quarter of 2008 when we takeoccupancy, but we will have to record approximately $400,000 of additional rentexpense per month in the interim period.  We expect to incur approximately $600,000 ofthis non cash expense in the fourth quarter of 2007.

In addition to our formal guidance,several of you have asked about updated expectations for cash flow for the fullyear, so I wanted to give an update.  Wehave slightly outperformed year to date against cash flow from operations.  It is my expectation that we will continue todo so in the fourth quarter.  Currently,our expectation is that we would achieve cash flow from operations ofapproximately $60 million.

That concludes the discussion ofBlackboard's financials. Now let me hand it back to Michael Stanton forclosing.  Michael.

Michael Stanton

Thanks Mike.  We are going to be on the road to seeinvestors in a few different cities in the coming weeks and months, we'll be inNew York and Boston,and we will be in New York tomorrowand Boston in two weeks.  We will also be presenting at a few upcomingconferences, we'll be at the UBS Technology conference on March 14, and we willbe at the Credit Suisse Technology conference on November 28 in Phoenix, Arizona. 

Again, I just want to apologize forany of the technical difficulties that folks had with our conference callvendor.  Operator, that wraps up ourformal comments.  Let's go ahead andstart Q&A.

Question & Answer Session

Operator

[Operator Instructions] Our first questioncomes from the line of Tom Roderick with Thomas Weisel. Go ahead.

Tom Roderick - Thomas WeiselPartners

Good afternoon and thank you.  Looking at the cash flows, Mike, you talkedabout this briefly at the end of your script here, but it was a big quarter forcash flow.  I was wondering, if you couldjust sort of review the evolution of your collections process there where youhave gone back to customers with a formal invoice process.  How did that work our throughout the quarter,was there sort of an artificial bump within this quarter on cash flows andshould we still expect to go back to sort of normal cash collection trends aswe look into the fourth quarter here?

Mike Beach

I think it's been positive.  I think it will take about a year with theprocess in place to get all the improvements out of it.  So, we're expecting continuing improvements butit did result in some level of improved cash flow during the quarter and we areseeing a significant decrease in the efforts that we need to make in ourcollections front, which is exciting.

Tom Roderick - Thomas WeiselPartners

Looking over at the total number oflicenses here, a little bit surprised, I guess, to see the Enterpriselicense down on a sequential basis and no growth in the number of outcomesdeals.  Can you speak to those specificnumbers knowing that it is a big renewal season, can you speak to those numberswith reflection of what is in your pipeline and should we expect to see somemore deals coming in the next few quarters on the outcome side?

Michael Chasen

Sure, let me actually tackle bothof those questions separately.  So firstof all, just talking about our overall license count, we do have a good deal ofseasonality, when it comes to our license count.  If you take a look even over last year, thedifference between Q2 and Q3, we have the largest number of renewals in Q3which also means we have the largest number of drops in Q3.  So, usually if you take a look at the growthfrom Q2 to Q3, we have a lot of new client sales in Q2, a lot of new clientsales in Q4, but a large amount of drops in Q3 which usually means our numbersare a smaller increase from the previous quarter.  So, while total Enterpriselicenses increased 12%, you have to factor in the seasonality as part of that.

When you take a look at the sales,we have been doing higher value deals, and we've had also some benefit ofpricing increases, and our retention numbers have been very good.  So, we're actually pleased with where we'vebeen from an Enterprise sales perspectivein the quarter and thinks this is very much in line with where it has beenprevious years for Q3 as well.

In addition, if you think about theinvestments that we're looking to make and we've talked about on the call,we're very excited about the opportunity to increase the number of new clientsthat we have adopting our technology.  Wethink were putting in place several programs that are going to cause new clientadoption to pick up as well.

When we talked about our OutcomeSystem license, we just came out with that product, as you know, at thebeginning of this year, and we anticipated about a yearlong sales cycle.  We were actually pleasantly surprised to beahead of our own internal expectations when we achieved 21 licenses at the endof last quarter.  We are pleased at thepipeline buildup that we've been seeing and certainly think that you're goingto be seeing increasing sales on that in future quarters.  Again, just because of the timing of the salescycle and the seasonality institutions, we didn't see an increase for thisspecific quarter but are more than pleased for where we are for the year.

Tom Roderick - Thomas WeiselPartners

Michael, one last follow up for youon the outcomes there itself, you obviously had a big win with the state of Mississippias we get into the election timeframe.  Does that have any impact on other potentialstatewide deals, should we look for any of those coming within the next fewquarters?

Michael Stanton

Yes, Tom. This is actually MichaelStanton.  I've been spending a bunch oftime with sales and actually we all have, looking at some of the trends. Already,we're finding that deals like Mississippi,not only is it helping us in the state of Mississippi.  We feel like we've got some really greattraction in the K-12 market right now specifically and have high hopes for somegood size deals there at the K-12 level in the state.  We’re seeing more and more deals in statesacross the country.  

You might have noticed last week weannounced a formal K-20 initiative that we are funding and investing in.  And definitely with sort of the electioncycle, we think that education is very much a hot button issue, but we thinkit's sustainable beyond that.  Thereality is that there's going to be more of this K-20 traction and we're tryingto position ourselves as best we can to take advantage of those opportunities.

Tom Roderick - Thomas WeiselPartners

Great, thanks, helpful guys.

Operator

Our next question comes from theline of Amy Junker with Robert W. Baird.  Go ahead.

Amy Junker - Robert W. Baird

My first question is Mike, can youmaybe quantify, I know one of the issues in the quarter in terms of the EPS youtalked about it last quarter was that you had a larger number of userconferences fall in this quarter.  Canyou just quantify, what that impact was versus perhaps what the mix looked likea year ago?

Mike Beach

It is in the $1 to $1.5 millionrange.

Amy Junker - Robert W. Baird

Okay, great, and then, Michael, canyou maybe talk a little bit more about your opportunity internationally,specifically I guess, I am interested outside of the U.K.and Western Europe. You hosted your first Middle East summit during the quarter. Can you talk about what you learned there, what the trajectory is, andhow soon we could potentially see the impact from growth in that region?

Michael Chasen

Sure, thanks Amy.  I recently got back from a trip to Dubai,where I had the opportunity to visit with 30 different institutions and meetwith a number of clients that are using our technology in the Middle East.  In fact, just nextweek, I am off to Chinato our user’s conference there, where there will be over 200 schools that arenot using Blackboard technology.  Both ofthose regions I really classify as early stage emerging regions that certainly,we believe, have some longer term potential but are just now starting to investin the technology infrastructure to bring their institutions online.

One of the things that I notice,especially as I visit these countries that are just starting to put a lot ofmoney into developing their e-learning technologies, is the effect in how muchthey look to what has been happening in the US and the European markets thatthey are interested in duplicating in their regions as well.  So, when we're abroad and we're speaking withinstitutions and they say what are the leading institutions in the UnitedStates using and those institutions are using Blackboard, that goes a long wayto help convince them to also use Blackboard technology, and I think that givesus a strong base to leveraging our install base in the United States thanoutside in these other countries. And that's definitely affect we're seeing inthe Middle East and seeing in Chinaas well

.

Amy Junker - Robert W. Baird

Can you just share what percentageof your revenue now is coming from international?  I know it has been growing over the lastcouple of quarters.

Mike Beach

Amy, this quarter was $13.2 millionof the revenues were derived outside the US.

Amy Junker - Robert W. Baird

Great, and then this last questionand I'll pass it over, in terms of your ASP hosting, you listed several customerswho have added, but looking at the numbers, the units are only up two.  Is that a case that some of those customersthat maybe dropped in the quarter were hosting or is there something elsethat's offsetting that?

Michael Stanton

That's definitely the factor.  So, if we churn clients through our peakrenewal period, what we're finding is that our clients are coming back to usand doing more with us in terms of hosting, which it doesn't necessarilytranslate to that unit cap that we give, so you see sort of unit count up justtwo units.  That doesn't truly reflectthe growth that we're seeing there.  Thedeals that we described on the call, I think that we had five or six that wenamed in higher education, those were all substantial, six figure, recurringrevenue ASP deals.  Similarly, the onesinternationally were more of the newer ones, so we see some churn of the lowdollar ASP relationships and we see added back higher dollar recurring ASPrelationships.

Amy Junker - Robert W. Baird

Perfect. Thanks guys.

Operator

Our next question comes from theline of Kash Rangan with Merrill Lynch. Go ahead.

Kash Rangan - Merrill Lynch

Thank you very much.  To sort of get a clearer understanding of theinvestments, Michael, you pointed out you were putting in place in the productdevelopment support in ASPs.  What is thetop point of these investments in terms of operating expenses, and when shouldwe start to experience the revenue productivity from these investments?  It looks like you are definitely talking aboutoperating margins being relatively flattish for 2008.  If you can just talk to the trajectory of howyou should be thinking about our models for operating margins as we workthrough different quarters of 2008?  Whenshould we expect to see the revenue productivity? Is it going to be more 2009as a result of these investments or is it one where you are investing, we takemargins flat but we get the revenue outlook in 2008 itself so the net result isactually not going to change our models?  How should we think about your investmentprofile?

Michael Chasen

Sure. As I mentioned, we are justseeing a large amount of growth opportunities across all of our differentmarkets, higher ed., K-12, international of the commerce business, and we wantto be able to fund those investments to allow us to grow revenue at the highend of our target operating model, which is 15% to 20%.  We think that we can actually make thoseinvestments and maintain stable to slightly expanding margins over the courseof the next year.  We'll actually givespecific 2008 guidance on our year end call.  It is a little bit more specifically, certainly,we expect to start ramping up those investments throughout 08’.  We believe we'll start to see kind of arevenue benefit in 08’ and 09’.  To talka little bit more specifically about the margins, Mike.

Mike Beach

Well I think the one thing to keepin mind that's important is to keep in mind how our revenue is recognized.  So, investments in 08’ will translate intoincreased revenues or increased sales in late 08’ and into 2009, but since werecognize revenue ratably, the revenue benefit really is going to be a 2009event.

Kash Rangan - Merrill Lynch

So at some point, we should model adip in your operating margins in 2008 and then a corresponding pick up in 2009?

Mike Beach

No, I think what we're saying isthat our current expectations are that operating margins excluding stock basedcomp will be flat to modestly up in 2008, and we'll give additional guidance onthat in the Q4 call.

Kash Rangan - Merrill Lynch

Got it, great. That's all I had.Thank you.

Operator

Our next question comes from theline of Jeff Lee with Signal Hill.  Goahead.

Trace Urdan - Signal Hill

Hi, this is Trace Urdan.  My question was when you guys did the convert,I think there was maybe set an expectation that you might be buying some of thefeature sets, and I kind of glean from your comments today that you're talkingmore about maybe building, especially in the K-12 arena.  I'm just wondering, if you could sort ofcomment on what the outlook looks like for you guys to sort of buy externalcompanies or products to augment your offering in the market?

Michael Chasen

When we talk about our productplans, we are always taking a look at the opportunity either build itinternally, OEM it from one of our close partners, or acquire the technology, andthat is certainly the case as we talk about these different expansions inproduct development as well.  So, wecontinue to analyze what our different options are going forward.  We think that the plan that we've laid out islikely to certainly be a lot of internal development, but we'll look to exploreother opportunities as well.

Trace Urdan - Signal Hill

So, just to make sure that Iunderstand, as you're talking about kind of a pick up in the K-12 space and thedesire to make your product more specifically suited to that K-12 market.  Could we expect just as well to see you buyingthings, as well as, building things?

Michael Chasen

Well, I think actually it wasn'tjust specific to K-12.  Certainly, we'restarting to see a lot of opportunity as we recently announced with our K-20initiative that we're seeing not only increased pickup in the K-12 marketspace, but also in the connecting of K-12 to higher end and continuingeducation.  So, we are going to be makingspecific product investments there, as well as in the commerce suite line ofbusiness, we're continuing to see increasing opportunity in that market as welland are looking to be able to improve investment in that space also.

The other item that I talked aboutthough was really in a focus on stability and scalability for the clients usingthe Legacy WebCT learning system products.  We really have been working over the pastseveral months to make sure that that product was stable and secure so that clientswere comfortable as they then didn’t look to other products in our academic suiteto be able to expand their e-learning initiatives on their campus.  So, we've been making a strong investmentthere, we're going to actually continue and increase that to make sure thatthose clients are on a stable product so that they can feel good about expandingtheir product suite and their relationship with Blackboard.

Trace Urdan - Signal Hill

Okay. Thank you.

Operator

Our next question comes from theline of Michael Nemeroff with Wedbush.  Please go ahead.

Michael Nemeroff - Wedbush

Hi guys.  Just a couple of questions it does look likethere was a little bit of churn, especially with the Learning System Enterpriselicenses.  Of the customers that churned,what percent of them were WebCT customers?

Mike Beach

Michael, we don't have that data.

Michael Nemeroff - Wedbush

Could you talk qualitatively to it?

Michael Chasen

I mean the qualitatively, I wouldsay that greater than 50% of the churn is going to be in the WebCT base.  These were folks that were probably in the LearningSystem Enterprise client count last year that were, again, in our client countbut were probably making plans to do something different for any number ofreasons and it takes sometime to make those decisions and get off the product.  So I think, again, coming through the peakrenewal season, we're sort of seeing that drop off.

Mike Beach

The one thing we can talk to sincewe don't have that information in front of us is clearly the retention rates ona combined basis were in line with what we experienced historically andconsistent with last year.

Michael Nemeroff - Wedbush

Then, Mike Chasen, if you couldtell us about how the cross selling into the WebCT customer base is going.  I know this is the first quarter that you hadproduct really available to sell in.  Canwe start to or can we expect a modest pick up in the quarterly contract valuefrom those initiatives starting in Q4, or will it be in Q1, Q2?

Michael Chasen

Well as we said previously, wereally expect that the WebCT cross sell opportunity will begin to manifestitself in 2008 and it will be a multi year opportunity.  It's just you've got to take a look at giventhe timing of the introduction of the new products and the current instabilityof the code base for a number of WebCT clients. We really didn't expect to see much progress in terms of Q3 unit sales.  As I mentioned in the investment areas thatwe're really looking to focus on, we are working to make sure that our productstability for WebCT client is a top issue for us, because really, those clientsneed to be on a stable e-learning system before they then want to look toexpand that e-learning system and get even more users and usage onto thesystem.

We are seeing a pipeline startingto buildup for that technology.  You alsohave to realize we just introduced that midway through the year.  Our typical sales cycle is six to nine months.  If you throw that on top of the fact thatWebCT was having these stability issues, you can see how very easily thatpushes new sales opportunities into the Q1 or Q2 of 2008, although I do believewe'll start to see some traction towards the end of this year there.

Michael Nemeroff - Wedbush

Okay then, Mike Beach, theinvoicing system, clearly still a little bit of an issue much less than lastquarter.  Will Q4, do you think that willmore normalized system process or will this take a full year before this startsto work itself out?

Mike Beach

Well, I mean, it is going to take afull 12 months until the numbers are comparable.  I think when we look at it; we're excitedabout the benefits that it is already driving from an expense perspective.  We're not going to need to expand ourcollection force and from a cash flow perspective, we're seeing renewals paidat a rate far faster than they have been in the past.  It's going to take a while until the processis perfect in terms of getting invoices out as fast as possible and I thinkthat will take about 12 months to realize all the benefits, but we're alreadyseeing DSO benefits in Q3 from the implementation of this.  So, we're excited about that we've seen sofar.

Michael Nemeroff - Wedbush

Okay and then just one last one forMike Beach.  Could you just give us whatthe non-recurring ratable product revenue was during the quarter?

Mike Beach

Non-recurring ratable was $5.5million.

Michael Nemeroff - Wedbush

Great. Thanks very much guys.

Operator

Our next question comes from theline of Trey Kuppin with Banc of America Securities.  Go ahead.

Trey Kuppin - Banc of AmericaSecurities

Just one quick question just to touchback on the investments that you're planning for next year, are you expectingto have that more front end loaded in the year where you do most of thespending or can you just provide a little bit of color on your plans for that?

Michael Chasen

No, those investments will be madepretty much across the year in each of the quarters and will certainly start toramp up in Q1.

Mike Beach

Yes, we expect it generally to beconsistent throughout the year and when we give guidance in Q1, we will clearlyidentify if there are any kind of lumpiness, but that’s not our expectationright now.

Michael Chasen

And keep in mind, some of thesethings we have already actually already started to fund here in Q3 and Q4.

Trey Kuppin - Banc of AmericaSecurities

Okay, and then, you may havementioned this I may have missed it but could you talk a little bit about theaverage ASP, what happened this quarter, was it consistent or growing slightlyor what did you see there?

Michael Chasen

Trey, I just want to make sure weheard that correctly. Average, so just sort of average deal size?

Trey Kuppin - Banc of AmericaSecurities

Yes

Michael Chasen

Well, I don't know what the averagecontract value per license I don't know what that was up as a percentage.  I don't have that immediately available thoughit should be pretty quick, pretty easy to calculate.  We're figuring out right here, but qualitatively,we're seeing bigger deals, we're seeing bigger ASP deals.  Again, we did have sort of the churn in units. But again, just qualitatively, I wouldsay that average deal size is going up.  Wehad the big deal in Estonia,which was effectively a countrywide deal in higher education.

Michael Stanton

And I think that not only are weseeing larger ASP deals, but we're getting them from not only new clients, butalso existing clients that are deciding to move into our hosting facility ifthey've just started to achieve certain levels of scale in their institutionthat they really believe they need professional management to be able to runtheir e-learning applications.

Again, we think that the unit countis a little bit misleading just because in Q3 is always our largest amount ofchurn because that's where the most clients actually have their renewal dateset, and while we had a small number of small clients turn off of ASP, we hadan equal number of rather large clients come join us, so we are starting to seea pick up.  The year over year growthlooks like it is probably about 16%.

Michael Stanton

That's contract value per license.

Mike Beach

Contract value per license is up16% over last year.

Michael Stanton

Pretty strong there.

Trey Kuppin - Banc of AmericaSecurities

Okay, great. Thank you.

Operator

Ladies and gentlemen, there are nofurther questions at this time. I'd like to turn the call back over tomanagement for any closing remarks.  Proceed gentlemen.

Michael Chasen

I think that's all we have for now. Thanks everyone for participating on thecall and we'll talk to you next quarter.

Operator

Ladies and gentlemen, thank you foryour participation in today's conference. That does conclude the presentation.  Have a wonderful day.

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Source: Blackboard Q3 2007 Earnings Call Transcript

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