Blackbaud, Inc. (NASDAQ:BLKB) Q4 2022 Earnings Call Transcript

Blackbaud, Inc. (NASDAQ:BLKB) Q4 2022 Earnings Call Transcript February 14, 2023

Operator: Good day, and welcome to Blackbaud’s First – Fourth Quarter and Full Year 2022 Earnings Conference Call. Today’s conference is being recorded. I’ll now turn the call over to Steve Hufford. Please go ahead, sir.

Steve Hufford: Good morning, everyone. Thank you for joining us on Blackbaud’s fourth quarter and full year 2022 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. With that, I’ll turn the call over to you, Mike.

Mike Gianoni: Thank you, Steve. Good morning, everyone. Thank you for joining us on the call today. I would like to take a brief moment to mention that Steve has taken an internal opportunity to further advance his career at Blackbaud and is transitioning to another role in the company. Congratulations, Steve. Thank you for leading our IR program over the last several years. Moving forward, Kevin Mooney, our Executive Vice President of Corporate Strategy and Development and his team of Alex Turkey and Jeff Klein, will take over the leadership of our Investor Relations program. Our remarks today will focus on three key areas, I’ll start with a review of the numerous steps we took throughout the year to improve company performance.

Next, I’ll give a brief overview of fourth quarter and full year 2022 results versus our guidance. And then I’ll end with our 2023 outlook before turning the call over to Tony to provide additional detail. 2022 was a year of substantial progress for our company. We proactively took steps to better position the company, manage it efficiently and effectively in a weakened economy and drive profitability, cash flow and improvement on Rule of 40 . On the revenue front, we institutionalized our pricing approach. We increased transaction fees where warranted, set subscription prices based on contract term lengths and embedded escalators in our 2-and 3-year contract renewals. We improved our renewal and retention processes by establishing a dedicated team and remaining focused on customer success.

In the fourth quarter, we signed several new and existing enterprise customers to 6 and 7-figure ARR contracts, including the company’s largest deal in 2022 closed by the EVERFI team. We were also active on the cost side of the business. We tightly managed our largest expense, which is people costs. We selectively replace attrition, closed open requisitions and had a work force reduction late last year. As a result, we ended the year with fewer employees than we had at the end of 2021. We also maintained our lower run rate on rent expense as well as travel costs. Further, we renegotiated some of our largest vendor contracts such as Microsoft Azure and AWS and simultaneously reduced our footprint by closing 4 data centers last year. In short, we examine every cost driver in the business with a critical eye, which took a lot of cost out of our company.

We have a strong internal focus at every level of the company to generate significant value and drive substantial improvement on the Rule of 40. Now let’s turn to our financial results. We saw a strong December and overall fourth quarter bookings performance with year-over-year improvement in our social sector. In the fourth quarter, we had total revenue growth of 11%, and our organic revenue grew approximately 2% at constant currency. Onetime revenue was roughly one point of drag on organic growth in the quarter. Adjusted EBITDA grew 12% with an adjusted EBITDA margin at constant currency of 25%. Taken together, Rule of 40 in constant currency was approximately 27% for the quarter. For the full year, our financial performance met or exceeded our guidance ranges we gave on our Q2 call last year.

We achieved a significant milestone in 2022. Revenues surpassed the $1 billion mark for the first time in our history, reaching $1.58 billion a 14% increase year-over-year. Organic revenue grew 4% at constant currency. Our renewals continue to improve throughout the year as we shifted towards multiyear contract terms, and our transactional business was a meaningful contributor to growth for the full year. Adjusted EBITDA margin at constant currency came in at 25% and exceeded the top end of our full year guidance range and Rule of 40 at 29% for the year at constant currency increased by 2 points over 2021. The business generated strong adjusted free cash flow of $154 million, which exceeded the high end of our full year guidance range and enable debt repayments ahead of schedule.

During the year, we also made improvements to our corporate governance by formalizing our policy on board member tenure. Most recently, Yogesh Gupta and Rupal Hollenbeck joined our Board of Directors in December replacing Tim Chou and Joyce Nelson who retired. In a little over a year, 4 of our 7 independent directors have been newly appointed. This not only provides diverse new business perspectives, but has also added important skills in cybersecurity, enterprise software, digital transformation and global operations. I couldn’t be more pleased and appreciative of the Board that we have. Turning to 2023. I’ll start by reminding you that the end markets we serve are large and resilient, the U.S. non-profit space alone, total annual giving is $485 billion.

There are over 1.4 million registered nonprofits and it’s the third largest employment sector in the U.S. And in the corporate market, we were greatly expanded our footprint with our EVERFI acquisition. And it’s clear that this market is sustainable to choppy economic orders. In fact, charitable giving in the United States has comprised about 2% of total GDP for more than 40 years and has only fluctuated modestly downward in 1 of the past 5 recessions. That said, we remain laser focused on improving operating performance and driving efficiencies in the company. With that, we are reducing our workforce, starting with notifications today in the U.S. following the planned action at the beginning of the fourth quarter to reduce overhead and rebalance our workforce.

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We experienced a slowdown in voluntary attrition relative to expectations, leading to a further reduction in force to achieve our original plan. We did not come to this decision lightly as we know it affects valued employees. We’re taking the necessary steps to work more efficiently and effectively as a company. It’s important to note that while we are eliminating positions in some areas, we’ll continue to hire in other areas. Most of these reductions are in areas of the business that are not customer-facing or in sales. And when combined with the cost actions we took in Q4, we expect our total headcount will be reduced by approximately 14% since Q3 2022. From a revenue perspective, our sales teams are fully staffed. We’re starting to see less attrition, and we have strong pipeline coverage as we head into 2023.

Our customer success and renewals teams are operating well, and we expect stable to slightly improve retention rates accompanied by the continued shift to multiyear contract terms. And while it’s still early days on the pricing initiatives, we expect to see improving performance with each successive quarter as contracts are renewed throughout the year. Additionally, these pricing initiatives have a double benefit to Rule of 40 with much of the revenue upside falling through to profit. Turning to profitability. We have high visibility into a step level margin expansion in 2023. The actions we’ve taken throughout 2022 and early this year are driving scale and efficiencies in the business. Our company is well positioned for substantial and sustainable margin improvement over the next several years.

While Tony will cover the 2023 financial guidance in more detail, I’ll provide the highlights. At the midpoint of our full year financial guidance ranges, we anticipate organic revenue growth at constant currency of 4%, consistent with last year. We expect adjusted EBITDA margin of 30%, which is a 5 point increase versus 2022. And consistent with our focus on optimizing the business, we expect Rule of 40 at constant currency to expand from 29% last year to 34% this year as we march towards attaining 40%. Further, we expect adjusted free cash flow of $180 million. Our capital allocation strategy continues to call for deleveraging in the near term as we gain more visibility on cost related to the security incident in 2020. We’re targeting a leverage ratio of approximately two times, significantly less where we ended 2022 at 3.2 times.

Collectively, we expect financial performance to improve with each successive quarter starting with meaningful improvement in the second quarter as our pricing and cost initiatives take hold. In summary, we had a strong execution in 2022. We’re focused on continued improvements across the business in 2023 as we progress along our Rule of 40 journey. We’re confident in our outlook with plans in place to achieve substantial performance acceleration throughout the year and deliver significant enhanced shareholder value. With that, I’ll turn the call over to Tony.

Tony Boor: Thanks, Mike. Good morning, everyone. Today, I’ll cover our results for the fourth quarter and full year 2022 as well as our outlook and guidance for 2023 before opening up the line for questions. Please refer to yesterday’s press release and the investor materials posted to our website for the full details of our Q4 and full year of 2022 financial performance. 2022 was a year of significant change. We started the year with a strong economy and lingering overhang from the pandemic. Conversely, we exited the year with a weakening global economy and minimal impacts related to COVID. Despite this changing environment, we remained intently focused on efficiency gains and strong execution across revenue, profitability and cash flow.

Against this backdrop, we met or exceeded our full year guidance ranges we gave on our Q2 call for revenue, adjusted EBITDA margin and adjusted free cash flow. In the fourth quarter, we reported total revenue of $275 million, adjusted EBITDA of $68 million, adjusted EBITDA margin of 24.7% and Rule of 40 of 25.1%. Revenue of $275 million represented organic growth of 0.4% and when adjusted for $4 million of negative foreign exchange impacts, organic growth at constant currency was 1.7%. Growth in the quarter was largely driven by contractual recurring revenue. We continue to see improvements in renewal rates and strong bookings in the quarter. This was partially offset by roughly one point of drag from onetime services and other revenue, and we experienced softness in the quarter in some payment services in the U.S. Adjusted EBITDA of $68 million grew 12% with an adjusted EBITDA margin of 24.7%.

We saw some early benefits from operational actions taken at the beginning of the fourth quarter in addition to actions taken earlier in the year. Rule of 40 at constant currency in the quarter was 26.6%. Turning to our cash and balance sheet. Our adjusted free cash flow was $8 million in the fourth quarter, largely driven by the timing of our cash collections shifting from Q4 into Q3 and a shift in cash tax payments from Q3 into Q4. Additionally, we had incremental spend in the quarter related to employee severance for those impacted by the workforce reduction late last year. We ended the quarter with $827 million in net debt with an additional $320 million of borrowing capacity. The debt-to-EBITDA ratio was 3.2 times, and we remain focused on rapidly deleveraging in the near term.

For the full year 2022, revenue of $1.58 billion was a record for us and fell within our full year guidance range. Adjusted EBITDA margin at constant currency of 25% and exceeded the top end of our guidance range. Taken together, Rule of 40 at constant currency of 29% was a 2-point improvement over last year and in line with our full year expectations. We generated adjusted free cash flow of $154 million, which exceeded the top end of our guidance range, and EPS of $2.69 also exceeded the high end of our guidance range. Now let’s turn to 2023. We remain focused on operational execution across our business that will generate significant improvements to profitability in the Rule of 40. As Mike mentioned, our contractual software prices increased at renewal dates throughout the year.

That, combined with realizing the cost actions we announced today should lead to successive quarters of improving financial performance starting with higher acceleration beginning in the second quarter. Our full year 2023 financial guidance is available in yesterday’s press release. I’ll cover some of the highlights. Starting with revenue. We see revenue in the range of $1.80 billion to $1.110 billion. We anticipate a negative FX impact of roughly $5 million for the full year, with most being front half loaded. This assumes no further material unfavorable movements in foreign exchange rates. At the midpoint, we anticipate organic revenue growth at constant currency of 4%. We expect an acceleration in our revenue growth as the year progresses with our pricing initiatives that are already in place, as well as new pricing initiatives coming online during 2023.

At the end of last year, we rolled out new contract pricing that go into effect as contracts come up for renewal. And as a reminder, our peak renewal season fall in July and December. We saw strong bookings in the fourth quarter have fully staffed sales teams in place with quotas increasing and a strong opportunity pipeline to start ’23. Also, we expect that onetime services and other revenue will continue to decline by 30% to 40% and versus 2022 driven by our continued migration to the cloud and our core business, as well as an opportunity to shift EVERFI onetime revenue to a recurring model. We anticipate between 150 to 200 basis points of drag on total revenue growth for 2023. Shifting to profitability. We remain intently focused on managing costs and driving significant improvement to margins throughout the year.

We anticipate adjusted EBITDA margin in the range of 29.5% to 30.5%, nearly a 5-point improvement year-over-year at the midpoint. As a reminder, Q1 is typically our seasonal low in profitability as certain annual costs related to employee benefits fall in the quarter. Additionally, we don’t expect the reduction in force we are taking today to have a meaningful impact to margin until Q2. Taken together, we are targeting Rule of 40 at constant currency of 34%, a 5-point improvement year-over-year at the midpoint, largely driven by our margin expansion efforts. Before I turn to cash in the fourth quarter we recorded an additional $18 million in aggregate liabilities for certain probable loss contingencies related to the security incident that we believe we can now reasonably estimate.

There are some potentially material security incident-related matters for which we have not recorded a liability, as we’re unable to reasonably estimate the possible loss at this time. Lastly, moving to cash flow. We anticipate adjusted free cash flow in the range of $170 million to $190 million, approximately 17% growth year-over-year at the midpoint . The year-over-year increase is driven by our expected significant margin expansion, partially offset by working capital changes and higher cash taxes. As a reminder, our adjusted figure excludes cash to be spent related to the security incidents. Our expectation for the full year is a net cash outlay of $25 million to $35 million for ongoing legal fees related to the security incident. In the near term, we remain focused on reducing our net debt with our cash generation, as we gain clear visibility into the timing and magnitude of any probable security incident costs, we will consider other alternatives to deploy our cash as well as continue to lower our debt to our targeted range.

As always, we will provide updates to the investment community and regulatory bodies through appropriate disclosures in our SEC filings. In summary, we had a strong 2022 and met or exceeded full year guidance across the board. In ’23, we expect to drive further operational improvements throughout the year that deliver substantial margin expansion and earnings potential. As a result, we expect 34% at constant currency on a Rule of 40 at the midpoint of our full year guidance ranges, up 5-points versus 2022, giving further confidence in our ability to reach our goal of 40% in the next few years. With that, I’d like to open up the line for your questions.

Q – Brian Peterson: Hi, gentlemen. Thanks for taking the questions. So I wanted to start on some of the pricing initiatives you guys have mentioned. I think the question I get a lot from investors is how do we think about the arc of those impacts? I know some of them are coming in on contracts and we get some transactional components. And any color you could provide on how much that’s kind of helping or how we should think about that as kind of a durable growth tailwind going forward?

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Q&A Session

Mike Gianoni: Sure, Brian, it’s Mike. A couple of things. Price initiative on transaction has started at the beginning of this year, so has contractual. And that really is sort of aligned with contract renewals also. Those have already begun. The ramp in those though for us historically and this year is, we have some pretty big renewal seasons, if you will, in kind of June, July time frame and then November, December time frame. So we’ll get some – and you see that in our guidance this year, we’ll get some benefit this year from those initiatives that will build in the back half of this year and more significantly in 2024 as well will get a full year impact in ’24.

Brian Peterson: Got it. Thanks, Mike. And Tony, maybe a follow-up for you or Mike, if you want to take this one. You mentioned on some of the transactional components some variability in the U.S. in particular. Any perspective on what kind of transpired over the fourth quarter? And any thoughts on how to think about the transactional growth maybe in 2023? Thanks, guys.

Tony Boor: Yes, Brian, the – we saw a little bit of softness at the end of the year, mainly in December on largely the BBMS side of the business. We did well in tuition management all year. We saw good growth, frankly, in transactions overall for the full year as well. A little bit of softness in December with year-end giving and it was actually volumes were up but the average transaction size was down a bit year-over-year. Bigger impact actually was FX. I think we had about a $2 million negative impact to FX also in the quarter on the transaction side. January is off to a good start. So we feel pretty good on the 23% number overall for transactions.

Brian Peterson: Thanks.

Operator: Thank you. Next question is coming from Parker Lane from Stifel. Your line is now live.

Parker Lane: Yeah, guys. Thanks for taking the questions. Just wanted to follow up on that last point there, Tony. I think you guys talked about charitable giving being relatively stable over the last 40 years. In those periods, of recessions, is it typical to see that average transaction size come down for a sustained period of time? Or is that something that you think is sort of an anomaly year in the fourth quarter?

Tony Boor: Well, I think when we look back at – we talked about this a bit on the last call as well, when you look back at past recessions, we’ve held up pretty well and certainly the industry has. I think the worst impact of any that we saw to overall giving was the ’08, ’09 period. I think giving was down slightly in the market or in the industry for 2 to 3 years before it fully recovered. We didn’t have nearly the mix of transactions back then that we do today. That said, we’ve had really good transaction volume all through this past year and started off January like in the JustGiving business. So that’s held up really well. Again, big events can drive giving as well like we saw with the war or the pandemic, et cetera. So there’s a lot of different drivers there.

But we’ve seen that hold up really well. I think probably the biggest thing we saw in December, maybe on giving Tuesday a little bit was potentially disposable income that, that may be driving a little bit of this dollar amount per transaction being down which is an impact, obviously, the economy. And that said, we did see higher volumes overall to finish up the year even though the economy has been tough. So kind of a little bit of a mixed bag on that front and January is off to a good start. So we feel pretty good thus far. We’ll have to wait and see what shakes out there.