Good day, and welcome to Blackbaud's Q3 2022 Earnings Call. Today's conference is being recorded. I'll now turn the conference over to Steve Hufford. Please go ahead, sir.

Good morning, everyone. Thank you for joining us on Blackbaud's Third Quarter 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 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.

Thanks, Steve. Good morning, everyone, and thank you for joining us on the call today. I'll open the call by saying we had a very strong quarter. We now expect to meet or exceed our financial guidance for the year which increases our 28% Rule of 40 performance expectation to roughly 29% on a constant currency basis. And next year, we anticipate a step-level acceleration in Rule of 40 performance into the mid-30s based on actions we've already taken and initiatives in place to drive both growth and profitability. Turning to the quarter. We had total revenue growth of 13%, and our organic recurring revenue at constant currency continues to trend consistently in the mid-single digits, growing 5% in the quarter. Year-to-date, our organic revenue growth at constant currency also stands at roughly 5%, and our adjusted EBITDA margin was roughly 25% at constant currency. Combined, we've achieved 30% on Rule of 40 through the first 3 quarters of the year, which leaves us very well positioned with only 1 quarter to go in the year. We remain confident in the resilience of our end markets, underpinned by some recent wins, continued strength in customer renewals and several pricing initiatives underway, which I will touch on shortly. And we're expecting to meet or exceed our financial guidance for the year and carry that momentum into 2023, which Tony will cover in more detail. Next year, we're targeting the mid-30s on Rule of 40 at constant currency through a combination of mid-single-digit organic revenue growth and an adjusted EBITDA margin approaching 29%. On the top line, the underlying trends in the business suggests mid-single-digit organic revenue growth as a solid baseline. We're also layering in several multiyear pricing initiatives, which are already underway and should provide additional revenue durability. And the…

Thanks, Mike. Good morning, everyone. Today, I'll cover our results for the third quarter and review our outlook for the remainder of the year 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 Q3 2022 financial performance. We had another strong quarter, leaving us well positioned as we head into the final quarter of the year. Third quarter total revenue was $261 million, representing total revenue growth of 13% versus prior year. Organic revenue growth for the quarter at constant currency was roughly 4% after adjusting for foreign currency impacts of approximately $5 million. Organic recurring revenue at constant currency grew 5% in the quarter. Our customer renewal rates continue to improve and we're seeing a continued shift towards multiyear contract terms. Also early pricing initiatives associated with our contractual revenue continued to gain traction, which is a very positive combination. Transactional revenue growth was positive despite the tough compare versus the third quarter of last year. This growth is supported by a continued shift in giving towards online donations, and we continue to make headway on our pricing initiatives like our 2 fee cover models that Mike shared earlier, that have the potential to be very positive tailwinds for our payments revenue going forward. Onetime service is another revenue was a 110 basis point drag on our total revenue growth in the quarter and as we anticipated, declined 6% year-over-year. Moving to earnings. Our third quarter gross margin was 60%. We generated adjusted EBITDA of $67 million, representing an adjusted EBITDA margin of 25.6% and diluted earnings per share of $0.69. Our year-to-date adjusted EBITDA margin of 24.9% is above our original expectation of 24% to 24.5%, which reflects the early…

[Operator Instructions] And our first question comes from the line of [indiscernible]

Thinking about the reduction that you talked about [indiscernible] the most in response to that. And then two, looking at that 500 basis point step-up in adjusted EBITDA for next year, should we expect that the workforce rebalance and reduction is going to have the largest impact on you achieving that 500 basis point improvement.

Yes. I didn't catch the first -- there's some feedback. I didn't catch the first part of your question. The second part -- this is Mike, by the way. The second part, the answer is yes, and we've already completed those cost reductions. We'll also see some impact, though, on things like improved sales productivity and several pricing initiatives underway. But the cost reductions will have a significant impact to the second part of your question. I'm sorry, I didn't hear the first part of your question. Can you repeat that?

Yes. The first part was really just focused on what areas are being impacted the most by the workforce rebalance either sides of the business or particular types of roles.

Yes. Not 1 area in particular, actually. We had both workforce reduction and elimination on some future open positions as well. So we're just remaining conservative on the cost side of the business, but no 1 particular area stood out on that list.

Got it. And then maybe 1 quick follow-up on EVERFI, you talked about the resiliency of the business through COVID and through the financial crisis back in '08, '09. EVERFI, obviously a newer asset to the company. How much resiliency do you see in that business in particular? And when it comes to the lighter bookings, is some of that just the result of sales turnover or lower execution rates right now that will soon improve. Can you provide a little more context there?

Yes, sure. We see that the business is a recurring revenue model business like [indiscernible] Blackbaud. There’s a lot of resiliency there with the customer base and the revenue line. The slow start to sales, there’s a couple of things that we’ve mentioned previously. One is sales turnover, higher than expected in the beginning of the year. We’re now fully staffed by the way. And secondly, we had a couple of enterprise deals coming into the year in the digital currency space that basically went away, given what’s happened in that marketplace. So some of those larger deals didn’t happen that we expected to happen in the beginning of the year. But we’re fully staffed in closing some nice deals, as I mentioned in my prepared remarks.

Our next question comes from the line of Matt VanVliet with BTIG.

I wonder kind of if we could get an update in terms of the Church Management product, how that's progressing? And what other areas of that product do you expect to sort of expand on in the coming years? and where you'll have sort of the most success landing some of those new deals?

Yes, Matt, I'll take that. It's Mike again. So in that faith-based marketplace, we're still selling in there, we've got a product portfolio of things that we've been selling over the years. The Church Management, in particular, has not really gone that well. So that product line Yes, it was a bit of a struggle. So we've looked to get a partner in that space. We're pretty strong in payments and fundraising and financials in that space. And we're also cross-selling our K-12 platform into the faith-based school systems, but the core Church product that we had brought to market and developed in its early stage a couple of years ago, we've really walked away from that core market and have looked to add partners and focus back on our core solutions there.

Got it. And then looking at the K-12 market or maybe the education market in general, is that proving to be a little more countercyclical? Or are you having success there? Or are you running into some longer sales cycles, much like we're seeing in other areas of the business?

Yes. No, the K-12 markets doing fine. We’ve got a big presence in that market, and we’re doing well in the market. We’ve got a really strong portfolio that covers almost all of the IT spend in those schools. We continue to sell great products there. There’s still a lot of cross-sell opportunity there as well. Given the product portfolio, we typically will sell a couple of products upfront and then we can come back and add modules, whether it’s in the school platform or tuition management, or fundraising or the financials and in fact, tuition management has been really strong year-to-date this year.

Our next question comes from the line of Kirk Materne with Evercore ISI.

This is actually Peter Burkly on for Kirk. Mike, maybe if I can just start by asking 1 to you. You talked about the pricing a little bit. I'm just curious, are these pricing actions largely on the transactional side of the business? Or are there opportunities related to pricing on the subscription side as well?

Yes, Peter, it's both actually. And there's a whole slew of these that are underway. We've talked about these. And our investor get kind of laid some of these out. There's a whole bunch of tracks of work going on here related to pricing on the subscription side and transaction and new products, like I talked about in my prepared remarks, the 2 products I mentioned, donor cover and Complete cover. So you could think of it in terms of opportunities on subscription, transactions and a couple of new products as well. And these will be rolling out going forward in '23 most significantly than we have in the past and over the next 2 -- 3 years also. So some will happen in '24 and '25, but we'll really see it ramp up in '23.

Okay. Tony, maybe just a quick one for you, and I appreciate the early look into '23 here. Just curious if there's any unique items that you'd call out from a cash flow growth perspective next year that we should be thinking about specifically just as it relates to EBITDA growth or if they should kind of flow together.

Yes. I think that the planned improvement in profitability should largely flow through to free cash flow. I wouldn't expect anything on the CapEx side to see any big surges there because we're moving more and more third-party cloud, so a lot less infrastructure investments we have to make CapEx wise. The one big wildcard probably outside of profitability on GAAP free cash flow versus our adjusted free cash flow that we're looking at now would just be where our security incident legal spend goes next year. It's very hard to predict what of those actions will get settled this year versus carry into next. That will probably be the 1 wild card on the regular free cash flow, but on the adjusted. I would say most all of that planned EBITDA improvement should fall through.

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

So just first on the revenue outlook, we're getting that growth outlook maybe 1 quarter earlier than we typically get it. I'm just curious, what gives you the visibility to kind of guide to that at this point? And Mike, I'd love to hear what you're seeing on the macro. I know that this is a more resilient market than most people expect or anticipate, but I'd love to get any thoughts there.

Yes, sure. I'll take those. So from a revenue growth standpoint, a couple of things. We're up nicely in sales productivity on the Blackbaud side EVERFI I have confidence it'll come back, but again, a slow start there. So sales productivity is going well on sort of core Blackbaud side. That's sort of 1 thing. Secondly, these pricing initiatives are under management control. Those will drive organic revenue growth and profitability. We kind of get a double on the Rule of 40, right, when you do that. And those are under management control. So we feel confident in and executing those. So both of those are contributing to organic revenue growth. What was the other part of your question?

Just on the macro environment and anything...

Yes. So we are a very resilient business. We went back and looked at our marketplace, our customers, donation trends, Blackbaud company performance back in kind of '07, '08. And the company grew through that, and we're a very different business now. First of all, we're much larger. And secondly, we're at 95% recurring revenue now. We were not back in '07 and '08. So we're a more resilient business model now in times of tough macros than we were back then. The company did pretty well back then. So the customers are very resilient. The biggest test for our market was COVID. And we did not see customers go out of business. We didn't see any of that. So we're quite well prepared for this inflationary period and any potential recessionary times that happen in front of us. And again, we look backwards and looking forward, I think we're in good shape related to that, really sticky customer base, our products are systems of record. They're not discretionary. So we feel pretty good about being a resilient business in this macro environment. We recapitalized the business and refinanced our debt in '20. So we have really good rates there. So we feel pretty good about that.

Mike. And maybe just a follow-up, just if I think about the totality of all the pricing initiatives you have, in terms of the arc of those benefits, how big is 2023 in that evolution? I know you said it's a multiyear effort, but I would love to get your thoughts on how that will kind of fold into the model over time.

Yes. We haven’t broken those out specifically, but you’ll see a step level change in ‘23 and then another one in ‘24 and somewhat more in ‘25. So – but ‘23 will be a step-level change because of where we are and where we’re going from a first initiation standpoint, if you will, on some of these. And a lot of these also are kind of market catch-ups, too. We’re a little behind in a couple of areas. So it’s not like we’re going to be overextending ourselves, I think, from a pricing standpoint. But you’ll see a step change in ‘23.

And our final question comes from the line of Patrick Schulz with Baird.

So really appreciate you guys providing additional color in 2023 for more organic revenue growth and operating margins. And you kind of alluded to that on the last question with the step-up function for margins. But should we be thinking about a step-up function for organic revenue growth, too? And what are your macro assumptions for '23 just regarding the macro environment? And I guess, in addition to that, too, as free cash flow improves, how should we be thinking about your top priorities of capital allocation, especially as your net leverage continues to come down?

Yes. So for '23, we talked about getting to the mid-30s on a Rule of 40. We talked about EBITDA getting up to 29 or so, which is a pretty big change. So that kind of gives you a picture of what we're thinking around organic growth, frankly, confidence is high, as I mentioned, because of high renewals and customer retention, bookings performance and pricing initiatives. I also mentioned, too, those pricing initiatives have a multiyear effect. So they're compounding as well, just to mention that. So we feel pretty good about getting that earlier visibility into '23. I think your second part was on CapEx. Tony mentioned that we're moving from our data centers to mostly Azure, but we have a pretty big footprint in AWS as well. So it's going to reduce our CapEx requirements going forward in the future. We're also -- we announced earlier this year, we closed one of our smaller data centers. We have plans to continue to do that, including next year as well. So that reduces requirements for CapEx, and it reduces our cost run rate as well.

And then Patrick, maybe I can just end this, Tony. From a capital allocation, obviously, that strong free cash flow would love to delever a bit more fully. So we're down to just over 3x. I think we're at 3.6 just post acquisitions. We've taken nearly half a turn off the table. Our optimal debt levels is somewhere around 1.8x to 2x leverage. So I'd like to deleverage. Obviously, we did the small acquisition with kilter. So we're still in that acquisition market. We've done a couple of divestitures as well. And then obviously, the board reapproved or refilled the buyback pool. So we still have $250 million. And obviously, that's something we'd look at it lot more closely as we get debt paid down and have more liquidity available to us, especially at where today's kind of valuations are.

Very helpful. And then just 1 quick follow-up with the pricing initiatives. How have customers react to that? I know it's a multiyear product, but are you seeing any customer pushback against that?

This is Mike. No, we have not. We’ve initiated some already in the past 18 months, nothing significant. But no, our retention and renewal rates are actually up nicely. So we’re not seeing any negative effects of that.

And we have reached the end of the question-and-answer session. And I'll now turn the call back over to Mike Gianoni with closing remarks.

Thanks, everyone. I’ll just close by saying that we had a really solid third quarter and expect to meet or modestly exceed our financial guidance for the full year this year, and we’re positioned to achieve the Rule of 40 target in the mid-30s at constant currency next year which is a step-level improvement over our 2022 expectation of around 29%. We remain confident in our outlook with plans in place to deliver significant enhanced shareholder value. Tony and I look forward to updating you all on our next call. Thank you.

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