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Executives

Michael Stanton - VP - IR

Michael Chason - President and CEO

Mike Beach - CFO

Analysts

Amy Junker - Robert W. Baird

Tom Roderick - Thomas Weisel Partners

Michael Nemeroff -Wedbush

Nate Swanson - ThinkEquity Partners

Richard Baldry - Canaccord Adams

Bennett Notman - Davenport

Nitish - Merrill Lynch

Trace Urdan - Signal Hill

Blackboard Inc. (BBBB) Q1 2008 Earnings Call May 7, 2008 4:30 PM ET

Operator

Good day, ladies and gentlemen and welcome to the first quarter 2008 Blackboard Earnings Call. My name is Latasha, and I will be your coordinator today. At this time, all participants are in a listen only mode. We will be facilitating our question-and-answer session towards the end of this conference (Operator Instructions).

I would now like to turn the call over to Mr. Michael Stanton, Vice President of Investor Relations. Please proceed.

Michael Stanton

Thanks, Latasha. Hello and thank you for joining us today for Blackboard's first quarter 2008 conference call. I would like to remind everyone that except for historical information presented, the matters discussed today may contain forward-looking statements, under the Safe Harbor Provision of the Private Securities Litigation Reform Act of 1995. Such statements are based upon management's current expectations and are subject to a number of risks and uncertainties that could cause actual performance and results to differ materially from those discussed in the forward-looking statements.

Among the important factors that could cause actual results to differ materially from those indicated by such forward-looking statements are: delays in product development, undetected software errors, competitive pressures, technical difficulties, market acceptance, availability of technical personnel, changes in client requirements, risks of international operations, general economic conditions, the integration of the NTI Group and such other risks as described in the risk factor section of Blackboard's most recent Form 10-K on filed with the SEC.

Blackboard undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events, or changes in future operating results. A few administrative notes as always related to some of the metrics we will provide today. First, we will be discussing non-GAAP adjusted net income and non-GAAP adjusted net income per share on this call, as additional information regarding our results. The measures are not in accordance with nor an alternative for GAAP and maybe different from other non-GAAP measures used by other companies.

Blackboard believes that the presentation of these non-GAAP financial measures provides useful information regarding additional financial and business trends relating to the company's condition and results of operations. A reconciliation of GAAP and non-GAAP metrics has been provided in today's press release, which is also available on the company’s website.

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

We once again posted supplemental information regarding licenses and contract value on the Investor Center section of our website at investor.blackboard.com. The document is titled, "Q1 2008 Blackboard Metrics."

On today's call with me are Michael Chasen, President and CEO, Mike Beach, our Chief Financial Officer. At this time, I would like to turn the call over to Michael Chasen. Michael?

Michael Chasen

Thanks, Michael. Hello everyone and thanks you for joining us today. Our financial results in the first quarter reflect a very strong start to the year exceeding both our revenue and earnings guidance. Our revenue grew year-over-year by 24% to $68.5 million, the product revenue growth increasing at 26%.

From an earnings perspective we also outperformed our guidance with GAAP net loss of $3.3 million or loss of $0.11 per share and non-GAAP adjusted net income of $2 million or earnings of $0.06 per diluted share. Our revenue over performance was driven by continued strong growth in our licensing and managed hosting sales and due to better than expected results from our acquisition of the NTI Group.

A few examples of first quarter deals in the US Higher Education market include Angelo State University; and Monroe County Community College, who both upgraded their basic licenses to the Blackboard Learning System Enterprise License and also added the Blackboard Community System and the Blackboard Content System. Charleston Southern University, a new client, which licensed the Blackboard Learning System, Commonwealth Medical College another new client, licensed the Blackboard Learning System, the Blackboard Community System and the Blackboard Content System, as well as our Managed Hosting Services to support their eLearning programs.

Brian University, the College of New Rochelle and National University all purchased our new Blackboard Connect product offerings. In Georgia Gwinnett College was licensed the Blackboard Transaction System, the Blackboard Community System and our Managed Hosting Offering.

Moving on to some of our international deals, in the first quarter our team had a significant cross-sale. The Blackboard Transaction System to a testament in Mexico. We test them for the total enrollment of more than 92,000 has been a long time client of our Academic Suite products and we are pleased to add them as a client of our Blackboard Transaction System.

In Ireland, the University College of Dublin contracted for our premium managed hosting offering to support their Enterprise Blackboard Learning System license and in Japan, where we continue to see strong traction, Osaka University licenses the Blackboard Learning System and Takushoku University added the Blackboard Community System license.

In K12, I would like to highlight two deals, including St. Mark’s School Schools, a private boarding school in Massachusetts, which became a new client. Saint Mark's have licensed the Blackboard Learning System, the Blackboard Community System and the Blackboard Content System for there are 350 students.

I mentioned this example because it showcases that Blackboard Technology is not just utilized by large data private institutions, but small schools as well. Lastly, Rochester Public School upgraded their basic license to the Blackboard Learning System, Enterprise license and also added the Blackboard Community System, the Blackboard Content System as well as our managed hosting service.

Now, over the past few quarters, many of you have asked us about our progress with the WebCT acquisition with regards to fixing the remaining bugs in the WebCT product and our progress in across down the other products to those institutions. In this past quarter, we made meaningful strides in both of these areas. As you know, our product development team has been working diligently to address the 100 of outstanding products issues in the WebCT product.

Over the past 18 months, we have issued three, major releases to stabilize the products. In February, we released the last major release version 8 of the Blackboard Learning System for WebCT client, which address substantially all of the major known issues, while we take a period of several months for everyone to move to the latest version. The initial feedback from our client base has been very positive.

Related to our progress in cross-selling, our other products to WebCT client, I am pleased to report this quarter we had a handful of WebCT cross sells and I thought I would share few of the initial sales details with you.

Capella University, a national leader in the online education, added the Blackboard Community System and the Blackboard Content System license to its existing Blackboard Learning System - Vista edition license. Similarly Villanova University added the Blackboard Community System and the Blackboard Content System licenses to its existing Blackboard Learning System - Vista edition license.

Additionally, George Mason University licensed the Blackboard Community System. Finally, McMaster University upgraded their basic license for the Blackboard learning system Vista Edition and licensed the Blackboard Community System and the Blackboard content system as well. This was a great start to what would be long term campaign to deepen our relationship with formal WebCT client.

As for the progress we are seeing with the NTI acquisition, let me share with you some of the additional details on our progress with the new Blackboard Connect offering. In the quarter, there were nearly 150 new Blackboard Connect deals closed and more than 20 Blackboard Connect deals were close with existing Blackboard US Higher Education clients. I am pleased with this result, given that this was a new product and our sales team only had two months to learn the product and begin selling it.

Moving on to licenses, we ended the quarter with a total 636 enterprise category licenses. Breaking out these licenses, we had 22,999 licenses of the enterprise blackboard learning system, 769 licenses of the Blackboard community system, 451 licenses with the Blackboard Connect System, 26 licenses of the Blackboard Outcome System, 440 licenses of the Blackboard Transaction System, and 2051 licenses of the new Blackboard Connect Offering. In terms of the Blackboard Learning System basic product, we had 938 licenses. The total number of licenses at the end of the quarter was 6974. In terms of our managed hosting business, we finished the quarter with 530 hosted clients, which is 16 % over the last year.

We finished the quarter with an annualized contract value of $244 million, which includes contract value for both Blackboard and NTI. This figure represents an increase of 27% year-over-year measured on a pro forma basis including NTI. As indicated in our first quarter 2008 Metric sheet, Blackboard’s contract value excluding NTI was $202 million, representing year-over-year growth of 20%.

Moving forward, we will not be reporting contract value separately, but we thought it was useful given the transaction closed mid-quarter. As our client examples, license figures, and contract value growth demonstrate, we witness to trend towards higher dollar value deals this past quarter. We are seeing this trend with both new and existing client institution. We are buying multiple products as well as our managed hosting service. Looking at our first quarter enterprise new sales, we found out that average deal size was up significantly from last quarter on a comparable number of total deals.

While we also experience the license churn in the first quarter, which will largely lower dollar value and within our expectations, we are pleased to see that client institutions are making larger commitments to Blackboard, and I believe this speaks directly to our long-term value proposition.

Our total headcount at the end of the first quarter was 1033 people. We ended the quarter with 230 people in sales, 90 in marketing and business development, 226 in product development, a 190 in support ASP hosting and production, 132 in professional services, and 165 in operations. We ended the first quarter with 88 quota-bearing sales representatives, which was slightly lower than our plan. Our sales team was under staffed in a few areas including the United Kingdom and Australia. We have worked to add additional sales resources in these respective markets, which we expect will provide appropriate sales coverage for the remainder of the year.

Finally, I want to congratulate Russ Carlson, who I have promoted to lead our sales and marketing efforts in the U.S and Canada, as President of North America Higher Education. Russ succeeds Peter Segall, who will be leaving Blackboard at the end of the month to pursue and opportunity to become the CEO of a software company in another industry.

We wish Peter the very best in his new endeavor. As many of you know, Russ Carlson has spent the past six years in Senior Operational and Sales Management roles across Blackboards U.S operations, having served as Vice President of Sales in our Western U.S region, and more recently as President of our Commerce Suite operations, where he has done an excellent job.

Prior to Blackboard, Russ served in a variety of sales management and business development positions in Oracle, Manugistics, IBM professional services and AT&T. Now, I will turn the call over to our CFO, Mike Beach to cover our financial and future guidance. Mike.

Mike Beach

Thanks Michael. Before I began, I want to remind investors that our first quarter results include the operations of NTI for the months of February and March. As we discussed on our last call, the NTI acquisitions is going to impact our income statement for 2008 with the reduction of deferred revenues. The additional expense rate, a greater intangible amortization, as well as non-recurring integration cost.

I will organize today's financial review around the income statement, the balance sheet and cash flow and close with the outlook in guidance for the second quarter in full-year 2008. Revenue for the first quarter 2008 was $68.5 million, up 24% from the last year. The increase in revenue is driven by continued growth in the annual licensing of our enterprise level products including NTI, as well as the continued growth in our ASP hosting business.

In the quarter, we recognized an additional $2 million in NTI revenue over initial expectations due to the finalization of the deferred revenue adjustments. Product revenue for the quarter was $63.1 million representing an increase of 26% over the same quarter last year. Professional services revenues for the quarter were $5.4 million, which represents an increase of 1% over the prior year.

In terms of revenue characterization, we also break out our revenues by the nature of the revenue streams, which include ratable recurring, ratable non-recurring and other revenues. For the quarter, ratable recurring revenues increased 28% to $54.6 million as compared to $42.7 million in the same quarter last year. Ratable non-recurring revenues increased 8% to $5.5 million as compared to $5.1 million in the same quarter last year. Other revenues increased 12% to $8.4 million as compared to $7.5 million in the same quarter last year.

Moving on to gross profit, our gross profit for the first quarter excluding stock based compensation and the amortization of acquired intangibles was $47.9 million as compared to $40.1 million in the same quarter a year ago representing a increase of 20%. For the quarter our gross margin was 70% excluding stock based compensation and the amortization of acquired intangibles.

Total operating expenses excluding the cost of revenues, stock based compensation and amortization of acquired intangibles was $40 million representing a 39% increase as compared to $28.8 million in the same quarter last year. This increase in expenses is largely attributable to the inclusion of NTI in our results. For the quarter, we incurred stock based compensation expense of $3.7 million, and amortizations of acquired intangibles were $8.7 million. Our GAAP net loss was $3.3 million in the quarter resulting in a net loss per basic share of $0.11.

Adding back the amortization required intangibles, net of the associate tax impact, resulted in non-GAAP adjusted net income of $2 million or non-GAAP adjusted net income of $0.06 per fully diluted share.

In terms of balance sheet, we close the quarter with $62.4 million in cash and cash equivalence. Account receivable increased 31% to $53.1 million at the end of the quarter from $40.6 million at the end of the first quarter in 2007. Current deferred revenue increased to $114.9 million at the end of the quarter, up 20% from the $96.1 million at the end of the first quarter of 2007. Current deferred revenues related to recurring products at the end of the quarter totaled $102.7 million compared to $82.4 million at the end of the first quarter in 2007, representing a 25% increase.

Cash flow used in operations totaled $6.1 million and capital expenditures were 7.9 million in the first quarter. Our expectations for our cash flow from operations remained unchanged to $70 million to $78 million in 2008. Additionally, we continue to expect capital expenditures to be 8% of revenues for the year.

Moving on to guidance, investors should know as we highlighted in today's press release. We are revising our expectations with respect to net interest expense. We are adjusting net interest expense higher to reflect the impact of lower interest rates, on our cash and investments, which will lower our interest income.

We currently expect that net interest expense will be approximately $2.7 million higher for the year, than our original 2008 guidance. Blackboard maintains a conservative investment policy, which seeks to preserve capital and maintaining liquidity. This policy is served as well during the recent credit market turmoil and we have maintained our conservative position to ensure liquidity of our investments.

That said for the second quarter 2008, we expect revenues of $74.8 million to $76.8 million. Amortization of acquired intangibles of approximately $9.9 million, net loss of $2.9 million to $2.1 million resulting in net loss per basic share of $0.09 to $0.06, which is based on an estimated 31.1 million basic shares and an estimated effective tax rate of 35%

Non-GAAP adjusted net income, excluding the amortization of acquired intangibles and the associated tax impact of $3.2 million to $4 million, resulting a non-GAAP adjusted net income per diluted share of $0.10 to $0.13 based on an estimated 31.9 million diluted shares and an estimated effective tax rate of 39%.

For the full year 2008, we expect revenue of $310.5 million to $316.5 million. Amortization of acquired intangibles of approximately $38.3 million, which is $700,000 higher than our original guidance, net interest expense of approximately $5.3 million, net loss of $3.9 to $1.5 million resulting in net loss per basic share of $0.13 to $0.05, which is based on an estimated 31.1 million basic shares and an estimated effective tax rate of 35%.

Non-GAAP adjusted net income excluding the amortization of acquired intangibles and the associated tax impact of $19.5 to $21.9 million resulting in a non-GAAP adjusted net income per diluted share of $0.61 to $0.69 based on estimated $31.9 million diluted shares and an estimated effective tax rate of 39%.

I have two additional notes to our guidance related to the acquired deferred revenue of NTI and the company’s GAAP effective tax rate. As I stated earlier we have received a first quarter benefit from a lower than expected write-down on NTI’s deferred revenues in purchase accounting.

At this time I would like to provide investors with final deferred revenues adjustment from our acquisition of NTI by quarter and for the full year. The impact of the adjustments were result in a reduction in revenues of $3.1 million in the first quarter, $4.3 million in the second quarter, $2 million in the third quarter, and $700, 000 in the fourth quarter as compared to what NTI would have recognized as a standalone entity. Total deferred revenue reduction for the year will be $10 million.

During the quarter our GAAP effective rate related to our income tax benefit was 35%. I would like to highlight the depending on the amount of GAAP earnings and the mix of domestic first international income we may experience material variations in our GAAP effective rate during 2008.

This concludes the discussion of Blackboard’s financials. Now, let’s hand it back to Michael Stanton for closing, Michael?

Michael Stanton

Thanks Mike. Just a one note, we will be several upcoming conferences later this month including tomorrow’s Merrill Lynch Technology Conference. Then later in the month, we will be at Wedbush Morgan Conference and at the very end of the month, the Cowen and Company TMT conference in New York City.

That concludes our formal remarks. Latasha, we are ready to go ahead and begin Q&A. Thank you very much.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Amy Junker with Robert W. Baird. Please proceed.

Amy Junker - Robert W. Baird

Hi, good afternoon. First, if I can just have a clarification on your guidance and Mike Beach, I think you addressed this, but you only raised your guidance by 1 penny on the high-end and $0.03 on the low end. Is entirely due to the higher net interest income or interest expense that you are expecting or is there something else in there as well?

Michael Beach

Yes, so the net interest adjustment of $2.7 million for the full year and is going to be about $0.5 million in the second quarter, are driving those changes.

Amy Junker - Robert W. Baird

You have said that it was $2.7 million higher than you originally thought, just do you have what level you originally thought, so we just have a full year number of what you are thinking for that line item?

Michael Beach

I do not have that right in front of me right now.

Amy Junker - Robert W. Baird

Okay. I can follow-up with you off line.

Michael Beach

What your next question and we will try to pull that for you.

Amy Junker - Robert W. Baird

No problem. The 150 new Connect deals, the deals that closed in the quarter, that is great, that is a huge number, I guess, I just want to understand so 130 of those are actually new customers to Blackboard? If 20 came in existing customers?

Michael Chason

The 120 customers

Michael Stanton

The 150 clients, Amy was across all markets.

Amy Junker - Robert W. Baird

Okay

Michael Stanton

20 of them were Higher Education clients they were clients of Blackboard. So, they were significant number of new Higher Ed clients, but the 150 is across obviously K through 12, which is historically their biggest market.

Amy Junker - Robert W. Baird

Okay.

Michael Stanton

Higher Ed in probably a few in the CTY, the county government space, but definitely there is a reasonable number of new Higher Ed clients there.

Amy Junker - Robert W. Baird

Of the new clients, is it too early to tell us at this point and I got to see if are they interested in your suite of other products or what do you think the opportunity is to cross sell in to those new Connect clients?

Michael Chason

We are starting to take advantage of the relationships that NTI or Blackboard Connect product has with the over 1200 K12 schools and a number Higher Ed institutions. So, we are starting to take advantage of those relationships, to start showcasing our product and we had had some of early indication of interest there.

More so though, we are seeing a large amount of interest from our existing clients they have a Academic Suite and Commerce Suite products and wanting to now purchase the Blackboard Connect products. So, they were seeing a very strong level of demand in that direction.

Amy Junker - Robert W. Baird

Then last question on the Connect product and then I will pass it over to someone else, but is that business would you classify that as sticky of a business as your other products or is it will easier to switch if they are using someone else?

Mike Beach

Statically if you look at the renewal rate the business is actually more sticky than current products, but I think for different reasons, so once you install the Blackboard Connect product is certainly integrated with your backend systems, which makes it very sticky product. However, based on the technology the scalability, the stability and the success that client has with it, it makes it very reluctant to leave and try anything else especially something in something that is critical as mass alerts an emergency notification. So, the renewal rates are even higher than our own. So, I would say that is a very sticky product.

Amy Junker - Robert W. Baird

Great, thanks. I will pass it on.

Operator

Your next question comes from the line of Tom Roderick with Thomas Weisel Partners. Please proceed.

Tom Roderick - Thomas Weisel Partners

Hi guys. Good afternoon. I wanted to follow-up you had a nice summary judgment in the Texas Court relative to the Desire2Learn lawsuit that had been taking place quite a while. Can you just give us an update on the competitive landscape with respect to some of the players out there, how they are reacting to judgment in your favor and what are your plans going forward with respect to future potential litigation around the patterns that you hold?

Michael Chason

Competitively we continue to see a number of smaller players in the space that usually more regionally focus, so whether were dealing with clients here in the United States or around the globe. We still see a very competitive atmosphere and just different competitors depending on what region we are in. We only did analysis of the D2L product and believe that their product was infringing in our patents, which is why we brought the suit. So, I can not really comment on any potential future actions. We are really just focused right now on continuing to move forward with the single litigation of D2L.

Tom Roderick - Thomas Weisel Partners

Okay, may be switching gears over to some of your future growth initiatives and things out side of NTI. You talked about K-3,12 International and the Outcomes System being three big drivers. If you had to prioritize or give us a sense for which of those are moving the fastest. Could you lay that out for us, what you are seeing the most immediate traction with? Then, with respect to outcomes you had another couple of deals there this quarter. Just any further details you can share on the traction within Outcomes System and when we can start looking for to seeing more tier one customers, would be helpful? Thank you.

Michael Chason

Sure. Let me just ask you, so, your, the first part of your question, are you asking where we are seeing the largest dollar growth in the short-term, is that what you are looking for? What specifics areas we are focused on with regard to---?

Tom Roderick - Thomas Weisel Partners

That is exactly right. For the growth initiatives you have laid out, where're you seeing the best early returns?

Michael Chason

When we look at the growth opportunity, it is really divided into two different camps. So, when talk about what the growth opportunity is from a dollar perspective, we continue to see the most dollar growth going back to our existing base of clients and up selling them our other products, our Community, our Content, our Outcomes, and that certainly the new Blackboard Connect product, where we are taking advantage of relationship where we already have contracts in place. They are already using our technology and it is very simple to add additional enterprise level technology to the pace phase and we actually saw that very much this past quarter with both new and existing clients. As more clients signed up to expand their licenses with us or use our managed hosting services.

Now, the second really large amount of interest we saw this quarter that we think will yield a large dollar volume was, specifically the Blackboard Connect, even with only two months as an integrated company, our sales force saw tremendous traction of clients, existing Blackboard Academic Suite or Commerce Suite client that are interested in purchasing this type of technology, and that our Blackboard can offer and offer in an integrated way of our existing solutions where we are starting to see a very big pipeline developed with regards to that as well.

We also continue to see strong interest in the Blackboard Outcome System. Again, that is a little bit of a longer sale cycle. So, the sales cycle is just about a year or longer. It is really a premium priced product. However, we are starting to speak to more and more schools and the interesting thing about those schools is, they are not just talking to start the outcomes system, they are really talking to us, about deploying our entire suite of products, to bring our entire institutional mind, which is why it makes a little bit longer of a cycle. Every Outcome System sales is not just an outcome system sale, it usually encompasses Community and Content System as well.

So, even the overall number of Outcome Systems, made growth in the single-digit, it actually represents a large increase in overall licenses because of the additional sales that it gets tagged along with it.

Tom Roderick - Thomas Weisel Partners

Very good. Thanks for the feedback, that is helpful.

Operator

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

Michael Nemeroff -Wedbush

Hi guys. Thanks for taking my question.

Michael Stanton

Hey Michael. How are you?

Michael Nemeroff -Wedbush

I am doing well. Congratulations on a very nice and strong quarter. Michael Chasen couple of questions for you. I know that you are going or as you go to lot of these conferences, you are going to be asking, ask the question regarding the impact of the economy and the softening of the U.S economy on your sales.

If you could first comment on that. Then, also I would like to get a better handle on some perspective with respect to the Connect product, 20 new Higher Ed customers and about 2300 Higher Ed customers. Can you tell us, how many of your existing Higher Ed customers have an existing product that does what Connect does not and what kind of growth targets you are setting for those as well? Then, I have got a follow for Mike Beach.

Michael Chasen

Sure. Let me talk, address your question about the economy. We are continuing to see very strong demand for our products across all of the different markets, in Higher Ed, K-12, and in the International. There are lot of people who say that the education market is little cyclical. As unemployment goes up, where the economy slows down, more people go back to school. That causes large drives of investment particularly from community colleges or state institution, which usually more than offset any type of budget shortfall they may be seeing. Certainly in the K-12 space where budgets are more closely related to government. You know, they are seeing pullbacks in the overall spending. However, with people are looking purchasing in purchasing our product, there are two things that you have to take into account. The first is there are lot of time it is a small dollar amount that ends up just getting in a regular operating line of the budget. So, if you are a school and you are paying us $50,000 to $60,000 a year that less than one teacher, or one FTE and yet makes your school that much more effective and efficient. So, you are able to actually deliver education at a greater ROE then you were previously. So, it really from the schools perspective does not end up appearing as an expensive at the end of the day. So, I think just the continued interest we are seeing across the different markets and also just the overall stated economy, means that we really have some great opportunity to continue to expand our relationship with our existing clients, as well as the sign up a number of new clients across all of our markets. To talk about this specific numbers for Blackboard Connect, let met just make, to sure you fully understand the numbers that we have put out in the worksheet and reference on the call. Michael can you just--?

Michael Stanton

Yes, sure. Michael this Michael Stanton. So, I think your question was just relative penetration, how many folks have a similar type of offering. In the quarter, obviously selling 20 Connect products into existing Blackboard client is great. Better still is adding in the numbers, probably somewhere around another 25 or 30 non-Blackboard higher education clients through this new product, which we think long-term is going to be very valuable. We think that the Higher Education market is largely under penetrated for this type of offering. Of the new deals that we did, some of them were brand new systems and they did not have anything on campus. Then, we had a number of our handful of institutions that were replacing Legacy Auto Dialer technology and moving to fully ASP hosted offering that they just get greater scale and efficiency on and better service to the campus constituents.

Michael Nemeroff -Wedbush

So, based on your research, could you just give us may be a rough percentage, 10% of the US Higher Ed type and existing solution, where it was less than that?

Michael Chasen

I think, it is really hard to say specifically what percent will have an existing solution because certainly some schools, in these types of situations, may be just be using e-mail for examples of way to reach out to their client base, and certainly, some schools have Auto Dialers. However, we do not actually consider those schools with competitive solutions, because the solution that we are offering, which combines with mass notification capabilities of voice, e-mail, SMS, tax, support TTY, PDAs, and pagers and other devices, really makes us have a pretty unique offering. So, we think that the majority of that market is significantly under penetrated. So, I would say, I do not have the exact number, but I think only a very small percentage have anything similar to a competitive type of overall solution that we offer.

Michael Stanton

Then just one last point, I mean, the Yankee Group is the last industry research note of consequence that we are aware of from July of 07 and then had US Higher Education penetration at 12% to 15% I think it was.

Michael Nemeroff -Wedbush

Okay, and then just one quick one for Mike Beach, actually two, could you tell us what the hosting margins are and how they have been trending? Then, the investments that you had previously announced after Q3 to make in 2008, given the larger CapEx number, can we assume that most of those investments might have been made in Q1?

Mike Beach

So the margins for hosting are going to be in the 50% to 55% range. I think, over time, there is a potential to make them slightly better, but I do not think that they are going to get dramatically better. From a CapEx perspective there was CapEx related to the investment in the Australia hosting center in Q1. Also as you know we are moving to new office space, so the build out of our new office space is concentrated in the first two quarters from a CapEx perspective.

Michael Nemeroff - Wedbush

Then, just for modeling purposes longer-term you had mentioned 200 to 300 basis points improved, a return to that 200 to 300 basis point margin improvement. That is typical, that you have typically seen over the past couple of years. Any reasons to think that you can not return back to that normal improvement in 2009 at this point in time?

Mike Beach

Yeah, so I think, we have been talking more in terms of 200 basis points and we are comfortable that. We will return to that beginning next year.

Michael Nemeroff - Wedbush

Great. Thank you very much for taking my questions.

Michael Chasen

Thanks Michael.

Operator

Your next questions comes from the line of Nate Swanson with ThinkEquity. Please proceed.

Nate Swanson - ThinkEquity Partners

Hi, I guess. I was wondering in terms of the Connect product and the success you saw this quarter and as you look at your pipeline bill, I am wondering what you think, the longer-term growth rate for that product would be and then also if you could talk may be about the ASP growth and maybe ASPs for the Connect product in Higher Ed versus what you have seen in K12?

Michael Chason

Sure I mean what we have said in the past is I mean on a more mature basis we think that the Connect business is going to be more of a 30% grower over the next couple of years at least that is what we are expecting -- from its definitely going to moderate over time. The second part of your question was ASP Managed Hosting?

Nate Swanson - ThinkEquity Partners

ASPs for the Connect product in Higher Ed versus K12, are you seeing I mean on the Connect deals part of what is helping drive higher ASPs?

Mike Beach

The average selling price is currently total Connect deal is going to be lower than Blackboard. I think the difficult part with Connect is a very large school could be very high dollar sale; if you look at something like LA Unified that is humongous sale, but average currently the average selling price for Connect is going to be lower than Blackboard.

Michael Chason

Just to clarify our comments in the script, the average deal was up significantly compared to just Q4. We were doing apples-to-apples. We were excluding NTI from that, obviously NTI is a lower ASP as Mike mentioned.

Nate Swanson - ThinkEquity Partners

Okay. I am wondering what you think the attach rate going forward might be new customers attaching NTI to learning system.

Michael Chason

I think eventually really all of our clients need this type of technology. So, there is no limit to the amount of our installed base that really should. I hope we will be purchasing the Connect technology.

Nate Swanson - ThinkEquity Partners

Okay. Great, thanks you.

Operator

The next question comes from the line of Richard Baldry with Canaccord Adams. Please proceed.

Richard Baldry - Canaccord Adams

Thanks. Given the sequential up-tick and discussion in last quarter, it is pretty clear, there are some one-time charges to integrate, I was wondering if you can and those are embedded in the line items. I am wondering if you can talk about them as a call out either as an aggregate or even on the line-by-line basis.

Mike Beach

So, in total, non-recurring integration costs are about $700,000 during the quarter and we are in all of the line items. So, do not have the detail in front of me to break those out for you.

Richard Baldry - Canaccord Adams

I thought the number is going to actually be in the millions. I was wondering why there is a discrepancy.

Mike Beach

We are giving guidance to $5 million for the full year.

Richard Baldry - Canaccord Adams

Okay.

Mike Beach

There are only two months, obviously the acquisition in a number. So, we would expect that the $5 million number is still, where we will end up and 700,000 that was incurred in the first two months of owning NTI?

Richard Baldry - Canaccord Adams

Thanks.

Operator

Your next question comes from the line of Bennett Notman with Davenport. Please proceed.

Bennett Notman - Davenport

Thanks guys. Could you just talk a little about the large state contracts, it has been a little while since you had did one which came from Mississippi or Alabama, but its outcomes putting more those in the works and how long is that sale cycle and might we be getting to the end from those negotiations. Then also, just Connect play in to that being able to offer, unified stable and Connect solution help you in those negotiations as well.

Michael Chason

Yeah, we have an increase in the number of both the either statewide or large consortia deals that were currently in discussions with. That we want to duplicate what we have done with some of the deals from last year and the interesting thing is they are not necessary just deals with the Higher Ed or just the community college in a particular state, but also really K-20 initiative in many of the institutes that we are talking about.

We do believe that having the Blackboard Connect product will also help us in those types of situations because now the states can get actually get put together single contract that would cover a wider variety of technology of all which is mission critical.

However, I think we are also going to maybe see some just state deals of just the Blackboard Connect product as well because that is something that not only the institutions or education looking at, but city and state governments. So, I think you are going to start to see a trend of a coupled more state deals.

Now we want to be careful though because we are really still to talking at this point of a couple a handful, so when the sales cycles serving a lot longer than a average sales, but obviously the dollar price is more than a commensurate with that longer sales cycle.

Also specifically you asked about the Outcomes system, when we are talking to these states, the product that really, I think in many cases first enabled the states to be thinking about this, because they were looking at doing something and being able to a role of reporting from the different schools and do analysis of their educational process. All of which is only possible because the Blackboard Outcomes System.

So, you think that, actually the creation of that product category in that product itself. It is also what is driving a lot of interest that we are seeing from the state biological social level for the Blackboard e-Learning solution.

Bennett Notman - Davenport

Can you just talk a little bit about I know that is an elongated sales cycle. If you could maybe just talk about some of the hurdles you have to cross in typical deal and how we should think about that sales cycle just throughout its life cycle?

Michael Chason

I do not know if I really have an updated, at this point be able give an accurate analysis of that particular sales cycle. However, I mean you can imagine, we are dealing with sometimes either State Legislatures, or even Governors are involved because these really are high priority, very visible statewide initiative.

They involve the buying across the multiple governments put up the different educational groups as well. Lot of these not only we are dealing with the state legislators and education leadership, but they also go through in our key process, which has its own defined time line and setup committees. All of that being said I can not tell you that we are starting to see a pick up in interest from the state level and we are involved in more and more conversation each quarter.

Bennett Notman - Davenport

Great, thank you.

Operator

Next question comes from the line of [Nitish] with Merrill Lynch. Please proceed.

Nitish - Merrill Lynch

Yeah, hi guys. Quick question, just to follow-up on the Connect product, I do thought that just one module you are selling that NTI exhibit Q4 with 1500 customers, but did I see that in this deal metric you provided that the number of license for Connect is 1900. Can you please explain why that is?

Mike Beach

Nitish, you cut out halfway through, could you just repeat that question for us.

Nitish - Merrill Lynch

Sure. What I was saying is that NTI exhibit Q4 with 1500 customers and I would have thought that since Connect is just one product the number of licenses would equate to the number of customers, but yet when I see the Q4 numbers in the deal metrics, the number of license is for Connect 1900, yet you have only 1500 customers giving an average of 1.3 modules or licenses per customer. Why is that?

Mike Beach

So, the 1.5 was a round number and it was based off of where they were in during the fourth quarter and also did not include the January sales obviously. So, the 1900 numbers were we have ended up for the year.

Nitish - Merrill Lynch

However, for…NTI only module will equal to one customer, correct. That is the way you will license the deal, correct.

Mike Beach

Yes, one license will equal to one customer.

Nitish - Merrill Lynch

Okay, so I just need to revise my Q4 numbers then?

Michael Chason

Yes, that is correct. I mean, the information presented here are the final numbers. I mean, you will recall that we are doing a lot of work between closing and our year end earnings call, which was approximately, I think, two or three business days. So, that initial number may prove a little bit conservative. What you are thinking about is the right way that one license or contract should approximate generally speaking to one client.

Nitish - Merrill Lynch

No, I appreciate the fact that lot of work has gone into, I just wanted to clarify. Thanks, a lot.

Michael Chason

No, no good question.

Operator

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

Trace Urdan - Signal Hill

Hey, good afternoon. I am wondering if you guys, given your special position there inside the beltway, whether you have any inside into what kind of language is going to be included in the Higher Education Act relative to notification, and whether you think that is going to make a meaningful difference in your sale through or whether your customer's are anticipating that already, as I look at that Connect product.

Michael Chason

Yeah sure, I think the Higher Education Bill is likely to have language in it. There are actually a couple of things percolating up on the hill, both in the Higher Ed Reauthorization Act as well as other opportunities. These things in the farm bill as well related to Higher Education and these types of general technologies, and then there is something else that recently came out of the FCC. However, our expectation is that it is top of mind, up on capital hill as it is top of mind in many states. So, hopefully that should, that comes to past, put a little bit of wind at our back.

Trace Urdan - Signal Hill

Okay fair enough. I am wondering if you might, I know you do not break up the contracts this way. However, I am wondering, if you could give us, some color on how International and then K-12 versus Higher Ed contributed to the growth that you saw in the quarter from a contract, or number of contract basis? Is it becoming a more, is there any trend line there that you can talk to us about? Is K-12 becoming more significant either across the Board or any particular product there?

Michael Chason

I mean K-3,12 is definitely becoming more significant just by the fact that we have got the Connect product, which came out of the K-3,12 market. So, I think, that is definitely true. In terms of the core Blackboard business as you have noted over the years, I do not think there is anything that is super measurable or material change in the quarter. Mike

Mike Beach

I would say, things are consistent with what we have experienced here in the past.

Trace Urdan - Signal Hill

Okay what about internationally? Do you have anything to say there?

Michael Chason

I am, I think international, I mean, I know that International revenue grew over, little bit over 20% in the quarter.

Mike Beach

Year-over-year, it was up about 20%.

Trace Urdan - Signal Hill

Okay any commentary relative to where the contracts are growing? Is there anything, any kind of new lines in terms of what is being driven internationally versus domestically?

Michael Chason

No I mean, I think it is a similar pattern to how the U.S Higher Education market has developed. I mean, definitely, I think for the remainder of this year, we have good expectations. I mean, just to talk about our couple of markets. I mean, obviously United Kingdom is a very big market for us. In Continental Europe places like the Netherlands and Australia with a new ASP hosting facility, we think that that should drive a healthy amount of business, because that is business that we historically could not go after because of the country's loss about hosting student records and information. So, definitely we think we think we are doing the right things internationally. We also had Japan, again.

Mike Beach

Trace, I think the only difference, meaningful difference from kind of countries where we were being most successful is I think we are starting to see greater attraction in Latin American and we talked about that it has some deal on the call and I know that the sales force in Latin America is fairly excited about the opportunity for the full year. So, that is something that has not been as significant in the past.

Trace Urdan - Signal Hill

Okay. Does this Connect product resonates internationally at all?

Michael Chason

We are starting to have a couple of our international clients ask us about that so it is certainly generating interest. Right now technically it operates just in the U.S because of the relationships and the technology that we built out in our course. So, we are starting to look the opportunity to fully internationalize that product.

Trace Urdan - Signal Hill

Okay great. Thank you.

Mike Beach

So, before we move on, just to be responsive to Amy. I do not have the exact number Amy for the net interest guidance. However, I think the best way to think about it is net interest expense is going to be somewhere between $1.2 million to $1.5 million for quarter. Obviously it will get better as the year progresses as our cash balance is grown out. So hopefully that helps you out. We will move on.

Michael Chason

Operator?

Operator

I show no further questions in the queue.

Michael Chason

Okay great. Well thank you everyone. For spending the time with us and asking some questions or actually do we have another follow up call or follow up question?

Michael Stanton

No, we do not.

Michael Chason

So, thanks everyone for joining us and we will speak to you or see you over the course of the quarter, thank you.

Operator

This concludes the presentation. You may all now disconnect. Good day.

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Source: Blackboard Inc. Q1 2008 Earnings Call Transcript
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