Blackbaud Inc Q3 FY2021 Earnings Call

Good day, and welcome to Blackbaud's Third Quarter 2021 Earnings Call. Today's conference is being recorded. I'll now turn the conference over to Steve Hufford, Director of Investor Relations at Blackbaud. Please go ahead, sir.

Good morning everyone. Thanks for joining us on Blackbaud's third quarter 2021 earnings call. Joining me on the call today are Mike Gianoni, Blackbaud's President and CEO and Tony Boor, Blackbaud's Executive Vice President and CFO. Mike and Tony will make prepared comments, and then we will open up the line for your questions. Please note that our comments today contain forward-looking statements subject to risks and uncertainties that could cause actual results to differ materially from those projected. Please refer to our most recent Form 10-K and other SEC filings for more information on those risks. We believe that a combination of both GAAP and non-GAAP measures are more representative of how we internally measure our business. Unless otherwise specified, we will refer only to non-GAAP financial measures on this call. Please note that non-GAAP financial measures should not be considered in isolation from or as a substitution for GAAP measures. A reconciliation of GAAP and non-GAAP results is available in the press release we issued last night, and a more detailed supplemental schedule is available in our presentation on our Investor Relations website. Before I turn the call over to Mike, I'll briefly cover our investor engagement activities for the quarter. During the fourth quarter, our team will be participating in the Credit Suisse 25th Annual Technology Conference, Raymond James Technology Investors Conference, and Barclays Global Technology, Media and Telecommunications Conference. We will also be holding virtual investor meetings hosted by Stifel on November 10th and Baird on December 14th. With that, I'll turn the call over to you, Mike.

Thank you, Steve. Good morning everyone. Thank you for joining our call today. Third quarter results reflected a fantastic quarter of execution for Blackbaud, exceeding even our own expectations on a much improved market backdrop. We achieved near double-digit recurring revenue growth, which represents roughly 95% of our total revenue. Topline growth drove a roughly 10-point improvement on the Rule of 40 over the year, and we're on pace to potentially have our best free cash flow year in the company's history. I firmly believe we're at an inflection point for our market and our company as the shift to a digital-first world continues to accelerate. We've seen this shift as we have successfully transitioned to a remote-first company where we are building a connected, engaged culture regardless of where people are located. And we've seen this in our customers as they are meeting and exceeding new expectations with online grant applications, cloud-based fundraising tools, virtual walks, runs, and rides, time-to-entry capabilities for admissions and even virtual prayer walls for faith-based organizations, just to name a few. As I've mentioned before, the percentage of giving done online grew by 40% in 2020, with roughly a quarter of that giving taking place on mobile devices. We believe these trends are here to stay and we are transforming and accelerating how people and organizations connect by combining our end-to-end commitment to driving outcomes for our customers with our technology and services with increased velocity, performance, and scale, and we're just getting started as the vision we set for the SKY platform is becoming a reality. Also, last month, tens of thousands of customers and prospects joined us virtually at our annual conference, bbcon, to witness how the latest innovations from Blackbaud can help them drive more impact, while maximizing their time and resources. Turning to the remainder of the year, we are again raising our outlook for full year 2021. We have high confidence we will exceed the $920 million high end of our upside revenue scenario for 2021 laid out on our Q4 2020 call earlier this year. And we expect to see further acceleration in our full year recurring revenue growth rate in 2022. We're also raising our best estimate for profitability and free cash flow and we continue to believe Blackbaud is undervalued. Thus, we executed on our share buyback program again in the third quarter. We continue to execute on our four-point strategy and each are progressing well. Today, I'm going to provide an update primarily on our recent innovation efforts. As usual, following my comments, I'll turn the call over to Tony to cover the financials in more detail. A big part of our strategy is to delight customers with innovative cloud solutions to drive more impact. Over the past year, I've seen the innovation and determination of both our experienced experts and incredible new leaders who have joined our engineering, product, and customer success teams. I'm especially excited that over 50% of our newest team members come from backgrounds that are historically underrepresented in tech. We believe that by building a diverse team that reflects our customers and communities, we'll have deeper and more representative insight that drives impact throughout everything we do. We're not just helping our customers digitally transform the old ways of working. We're creating tools that offer breakthrough improvements and reinvent the way they accomplish outcomes and track results. For instance, we recently released an entirely new experience for Blackbaud Grantmaking and we've since converted every existing grant customer to the new platform, a great example of the vision we have for our entire portfolio. Another example is a major recent release on Financial Edge NXT, where we're transforming the entire accounts receivable experience. This provides a modern experience and new streamlined workflows and controls in areas such as invoice creation, billing, and receiving payments, as well as holistic relationship management across vendors, customers, and sponsors. And in 2022, we plan to release a new wave of data intelligence capabilities, extending our success in this area by bringing together the industry's most robust database of philanthropic giving with artificial intelligence to drive unmatched insights for our customers. We're also committed to giving customers the flexibility to benefit not just from Blackbaud's innovation, but the innovation happening outside of our walls as well. Our developer community is growing rapidly with more tools than ever to create new capabilities that extend Blackbaud solutions. We now have over 5,500 non-Blackbaud developers registered in our ecosystem. And we've seen substantial growth in the Blackbaud marketplace, where over 6,400 organizations have found a curated app to help them work smarter. I'm excited about the use cases we're seeing in the market, such as an app that integrates Shopify with Raiser's Edge NXT or a new API integrating Urcos with Workday, enabling our customers to easily connect employee data into the Urcos platform for more effective employee engagement. We're also enabling non-developers with low-code or no-code tools such as our Microsoft Power Platform Connector, to build automated workflows with our APIs without having to be a seasoned developer. We also continue to innovate as online gifts become a greater share of our customers' total donations. At bbcon, the team announced that giving checkout with our complete cover model is now available in the U.S. with additional markets to follow after seeing strong success in the U.K. You can think of giving checkout as an easy-to-add simple-to-use donation button that can be used by any nonprofit organization. Giving checkout differentiates itself from others with a complete cover model, where there are no processing fees for the organization. Instead, donors choose at checkout if they want to cover the processing fees. We've tested this extensively with great success in the U.K. with our JustGiving platform and it's a real win-win for Blackbaud and our customers. I'll summarize by reiterating that I believe we are at an inflection point for our market and our company with significant growth opportunities ahead. We're raising our estimates across the board for full year 2021 and we expect recurring revenue growth to accelerate in full year 2022. Our investments in the SKY platform continued to deliver results. We're focused on fueling future growth through additional investments in innovation, customer success, security and cloud infrastructure and a higher-velocity go-to-market motion. Our market has once again proven to be resilient and innovative in the face of a challenging pandemic environment, and we continue to strengthen our leadership position as the best long-term partner for our customers. Blackbaud is well-positioned to capture the organic and inorganic growth opportunities in front of us, while driving meaningful acceleration in financial performance. Overall, we had a very strong quarter, and we're well positioned to carry this momentum through the end of the year and into 2022. With that, I'll turn the call over to Tony before we open it up for Q&A. Tony?

Thanks Mike. Good morning everyone. Today, I'll cover our results for Q3 and our latest outlook for the full year before we open up the line for questions. You can refer to yesterday's press release and the investor materials posted to our website for the full details of our Q3 2021 financial performance. You've heard us say on previous calls that we expected an acceleration of revenue performance in the second half of 2021. Q3 not only delivered but exceeded those expectations. Recurring revenue grew 9.2% on an organic basis, and this should serve as a proof point for what's achievable as we execute against the 10 growth drivers laid out in our investor session earlier this year. Strong transactional revenue performance was a key driver of overall revenue growth and benefited from larger in-person events returning and a higher percentage of online giving compared to historical levels, a trend we believe has staying power. As an example of the success we're seeing here, JustGiving had one of their best revenue months ever. Our contractual recurring revenue, which is the core of our business, grew $3 million in Q3. We've seen year-over-year improvement in sales productivity per rep and overall ARR bookings with some of our early pricing initiatives starting to take hold. Also, we continue to see strong trends in renewals with our customer retention rate increasing in the quarter to 93%. One-time services and other revenue declined $2 million, which was approximately a 200 basis point drag on total revenue growth. Again, we expect this drag to bottom as soon as 2022, which should result in a lift on total revenue growth. For the second quarter in a row, the trends we're seeing in the business are leading us to raise our best estimates for the full year and we now expect to exceed the top end of our upside scenario laid out at the beginning of the year, which was $920 million. Moving to earnings, our third quarter gross margin was 59%. We generated adjusted EBITDA of $62 million, representing an adjusted EBITDA margin of 27% and a diluted earnings per share of $0.78. We laid the foundation for considerable margin expansion going forward. And through three quarters of 2021, we had an adjusted EBITDA margin of 27.3%, inclusive of our investments in areas like innovation, customer success, security and cloud infrastructure and a higher-velocity sales motion. Our best estimate for full year adjusted EBITDA margin of roughly 25% included certain investments being back-half loaded. While we're making good progress here, some of these investments are likely to push into early 2022, particularly in areas where we're increasing headcount. We continue to do a great job attracting top talent in a competitive labor market, but the rate at which we're adding headcount is less than we had planned. Our prior investments in the people and tools needed to create a best-in-class candidate experience are paying off and we've increased our recruiting capacity as we look to accelerate hiring. Given our revenue overperformance in Q3 and anticipated timing of investments, we now expect to achieve an adjusted EBITDA margin of at least 26% for the full year 2021. That brings me to the cash flow statement and balance sheet. Our free cash flow was $58 million for the third quarter, a year-on-year increase of $16 million, representing a free cash flow margin of 25%. Through three quarters, we've generated approximately $132 million of free cash flow, and our current plan has us on pace for one of the best years ever in terms of free cash flow generation. Our latest modeling suggests we're likely to generate at least $150 million of free cash flow, inclusive of the heightened investments planned for Q4. I'll also note that we completed $40 million of opportunistic share repurchases during the quarter. We still feel that the valuation today does not fully reflect where we're heading as a company. As of September 30th, we had approximately $111 million remaining and available under our current share repurchase authorization. We ended the quarter with $500 million in net debt. Our capital strategy calls for a debt to EBITDA ratio of less than 3.5 times. And at the end of Q3, we stood at 1.7 times, and we had $425 million of borrowing capacity. As we look forward, we're actively evaluating acquisition opportunities, and we plan to continue opportunistically executing on share repurchases when our internal estimates determine the company's shares are undervalued by the market. To summarize our outlook for 2021: From a revenue perspective with three quarters behind us, we have high confidence that we will exceed the high end of previous modeling of $920 million for the full year 2021 revenue, and that may prove to be conservative depending on our fourth quarter transactional revenue performance. Our full year recurring revenue growth is on pace to accelerate year-over-year. And looking ahead to 2022, our plans call for further acceleration in our recurring revenue growth rate. Shifting to profitability, we expect to achieve an adjusted EBITDA margin of at least 26% for full year 2021 inclusive of the ramped investments I spoke to earlier, some of which will carry into 2022. And our strong performance year-to-date, combined with our outlook for the fourth quarter suggests we should generate at least $150 million of free cash flow. I'll remind you, we could see some variability here depending on Q4 transactional revenue performance as fourth quarter tends to be our seasonal high for payments revenue. We will also continue executing against our capital deployment strategy which calls for ensuring access to adequate levels of capital to grow the business through balance sheet management, rigorous oversight of investments in the business, including acquisitions, and identifying and efficiently returning excess capital to shareholders including the option for additional share repurchases. In summary, during the third quarter, we saw a nearly double-digit recurring revenue growth, representing roughly 95% of total revenue. We achieved a roughly 10-point improvement on the Rule of 40 year-over-year, and we're on pace to potentially have the best free cash flow year in the company's history. We've raised our outlook for the full year 2021 and have increased confidence in our ability to accelerate financial performance in 2022 and the years to come. We have greater visibility to our near-term performance and while nobody truly knows how long the pandemic will last, we are increasingly confident in the resilience of our business, our market and our ability to accelerate our financial performance. We're aiming to achieve the Rule of 40 as a company and accelerating growth, combined with our margin expansion initiatives has us well positioned to accomplish that goal. And our proven capital strategy inclusive of M&A and our share repurchase program provides us with ample optionality to allocate capital in a way that maximizes value for our shareholders over the long-term. With that, I'd like to open up the line for your questions.

Thank you. We will now take our first question from Parker Lane with Stifel.

Hey guys. Thanks for taking my question. Mike, I was hoping you could talk a little bit about the pickup in sales productivity across the business. Are there any particular areas that you'd point to that you'd say have been incrementally positive relative to your commentary last quarter? Or is it mostly a balanced performance — are you seeing productivity improve across the board?

Yes. Thanks, Parker, for your question. We're seeing it across the board. We've gotten better at prescribing products for our SMB marketplace. We've seen improved productivity there. In all of our verticals, I look at the deals that we closed in the quarter and year-to-date, and we're seeing good performance across the different vertical markets and internationally. Canada is really cruising well and we're doing well in the Pacific and in the U.K. So, we've seen productivity improvements across the board on a year-over-year basis.

Got it. And then in terms of hiring, you mentioned that you're increasing your recruiting capacity or a little bit behind in the plan. Where are we seeing those investments? Is that mostly sales and marketing focus? Or again, is that an area where you're looking to accelerate R&D investments, maybe hiring there as well? How should we think about the mix of employees you're looking to bring on here as you enter 2022?

Yes, it's a couple of areas. You can see in the R&D line we're investing more there. Big focus there on infrastructure, security and innovation. We're adding more in sales and in customer success. So, those are the three big areas that we've been adding headcount this year and the last 18 months.

Got it. Very good to see you back and great quarter. Thanks.

Your next question comes from the line of Rob Oliver with Baird.

Hi, good morning guys. Mike, a question for you — calling out the inflection in the market, that's pretty exciting. I just wanted to dive into that a little bit more in terms of what you're seeing that is driving that inflection — is it kind of post-COVID normalization or return to in-person events? And then following up on that, do you think we're back to levels that we saw pre-COVID in terms of the potential for fundraising and fundraising events and some capital budgets coming back to your customers? I also have a quick follow-up. Thanks.

Yes. So, we've been saying for a long time that in the back half of this year we thought we'd see our return to growth and the third quarter proves that. We're seeing return of events. We're seeing our markets mix in-person and digital — they're actually combining in-person events with digital participation as opposed to only digital last year. We're seeing some of our markets open now that were closed before. We're also seeing a significant shift to digital-first and digital-only from a fundraising standpoint, which grew a lot last year. Online fundraising grew roughly 40% year-over-year last year, and that's here to stay. So, we're seeing all of that mix. The pandemic showed organizations they need a solid cloud partner to help them whether they're in the facility or not. So, it's a combination of things: transactions are coming back, bookings overall are strong, and productivity is improving. We are seeing that across the board. Also, we're implementing several pricing initiatives that we outlined at our Investor Day earlier in the year. Those take time to come to fruition — some are implemented, some are coming — so there's additional upside there going forward as well.

That's really helpful color, guys. Thanks. My follow-up is brief but open-ended: Mike, you talked about the pace of R&D spending. There's a definitely an impressive list of products coming out of the user conference last month including data and AI. I'm curious what you're most excited about when you look at that pace of innovation, which you guys have clearly dialed up. Which ones are you most excited about?

There are quite a few. We're really getting some excellent leverage out of the multi-use engineering platform that we've built, which we call SKY. It's an engineering system that's touching a lot of products, and we're using it across all of our verticals in one way or another. It's driving accelerated innovation. The biggest thing that we just completed was our Blackbaud grants management platform that has been completely transformed on the new engineering system, and we literally moved 100% of our grants customers to this platform in the last quarter. Now it's a modern go-forward platform. That's one of the items I'd highlight as a recently completed innovation.

Thanks again guys. Appreciate it.

The next question comes from the line of Brian Peterson with Raymond James.

Hi gentlemen. Thanks for taking my question. Mike, it's pretty clear in your commentary that the environment and the backdrop and the execution are getting better. Could you parse that out a little bit in terms of what's happening with net new opportunities versus activity in the existing customer base? Any color on how that split is looking would be helpful.

Yes. We're signing a lot of new logos in community colleges and nonprofits around the world. Our YourCause corporate platform is growing well and becoming more global in its footprint. We're seeing new logos across the board, and we've closed some big deals in healthcare recently. Year-over-year growth in bookings and sales productivity is quite strong. We have our sales team organized between hunters and farmers, and we're pleased with performance so far this year. Q3 was a good example of that improvement both in revenue growth and bookings.

Great. Tony, maybe a follow-up on hiring. I saw the press release that you guys are transitioning to a fully remote workforce. Would you expect that to help the hiring effort? How do you feel about getting to the hiring levels you planned for 2021 — will that bleed into 2022?

I'll start. We actually issued a press release about being remote-first, and it reflects the position we took over a year ago when the pandemic started. We continued recruiting and have been hiring folks who are not close to a Blackbaud office. A year ago we reduced some of our real estate globally. The transition to remote-first has been fantastic for us and has been working well for over a year. Our access to talent and diversity is unprecedented. We hire a few hundred people a year and now receive over 100,000 applicants for those jobs. People are excited about Blackbaud because we're a public cloud software company that serves mission-driven customers. We've been doing well from a talent and diversity perspective for well over a year.

I'll follow up. The challenging part has been attrition in the current labor market dynamics — we've seen attrition tick up as many companies have. It's not hiring per se that's been the problem, but higher-than-historical attrition. There's also some inflationary pressure on personnel costs that we're managing.

Got it. Thanks guys. Congrats on the great quarter.

Our next question is from the line of Kirk Materne with Evercore ISI. Please proceed with your question.

Hey guys. This is an analyst here asking on behalf of Kirk Materne. Thanks for taking my question. Two questions. First, you mentioned sales productivity getting better on the contractual recurring side of the business. Is there more room for productivity to improve there? And how do you think about the balance of adding capacity versus driving further productivity improvements when looking ahead to calendar year 2022?

We are doing both. Yes, there's room for improved productivity in sales. We've seen a nice year-over-year improvement, but there's plenty of room for more productivity. We're also adding capacity in a couple of sales areas as well, so both levers are in play.

The other area we're spending additional dollars on is digital marketing to drive more lead generation and take some of that work off salespeople so we can increase their sales velocity, which will increase their productivity.

We've also built a really efficient centralized sales hiring model that takes us a couple of weeks to hire and onboard new sales executives, which is a high-velocity model for us.

I appreciate that. And then just a quick follow-up. On the payments side, was there anything unusual from a seasonality standpoint in Q3 around one-time events? How should we think about payments growth heading into the holiday season?

We saw a sharp increase in online donation volume last year. Historically, total donation online percentages were sub-10%, and that jumped up to about 13% last year. We think that shift is here to stay, which benefits us. Also, because of the pandemic and fewer events in early 2021, Q3 this year had an easier year-over-year compare on online donations. Part of Q3's impact is returning toward a more normal level. We expect upside next year as events come back more fully and capacity increases for spring and summer event schedules. As we said in prepared remarks, we expect continued acceleration in overall revenue growth in 2022 versus this year.

Awesome. Thanks guys.

Our next question is coming from the line of Rachel Freeman with BTIG. Please proceed with your question.

Hi, this is Rachel on for Matt VanVliet. Thanks for taking my question. You touched on capacity constraints that you expect to ease in 2022. For next year, do you foresee seeing more revenue per customer with a hybrid approach of in-person and digital events plus more incremental digital events throughout the year? Or are you expecting a return to in-person events being the main events for customers?

We are seeing an increase in revenue per customer because of events coming back and events that didn't happen previously taking place now. We're also seeing higher ARR bookings in our sales performance. The industry is shifting more online which drives transaction growth for us as well. Last year online fundraising jumped from around 9% to 13% of total in one year, after many years of slower growth to 9%. That's a big jump and it's not going backwards. So, we expect a mix: more revenue per customer, higher ARR bookings, and continued shift to online and mobile donations.

We don't monetize all dollars that run through a customer's system — transactional items typically have variable pricing, which gives us benefit from increased online transaction volumes. Additionally, we are implementing pricing initiatives, including bringing the U.K. JustGiving complete-cover model to the U.S., which should increase revenue per customer. We have several pricing opportunities outlined at our investor session that we are rolling out, and those will help drive increased revenue per customer.

That's great. And then just on the return to in-person schooling in the fall, how did that impact transaction revenues during the quarter? And can you speak to how the K-12 market is performing overall?

The K-12 market is performing well. Our systems proved vital over the last 18 months because our customers were able to operate regardless of whether students were in class or not. Administrators had mobile access to our platform to run their schools regardless of student locations, so the quarter started well. We've seen a return in our tuition management platform. Many schools had a good start to the quarter. There's a lot of innovation happening on our K-12 platforms. We run user groups and have a close relationship with those schools to get feedback and discuss innovations. So yes, the K-12 market is solid for us.

Thanks. I'll hop back in queue.

At this time, I will turn the floor back to management for closing remarks.

All right. Great. Thank you, everyone. I'll just close by saying that third quarter was an excellent example of what we're after as a company. We achieved near double-digit recurring revenue growth, driving roughly a 10-point improvement on Rule of 40 year-over-year. We're on pace to potentially have our best free cash flow year in the company's history. As we said over the course of this year, we have multiple levers with which to accelerate revenue growth and margin expansion starting to take hold. First, the pandemic recovery with event-driven transactional revenue and bookings returning; second, a few pricing model and price catch-up opportunities; and third, we're actively looking at M&A opportunities. We've reiterated our outlook for the business. We believe steady execution against the Rule of 40 financial framework and our continued commitment to disciplined capital deployment will generate substantial shareholder value. Thank you, everyone.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.