Blackboard, Inc Q4 Earnings Call Transcript

123jump.com Staff
20 Feb, 2009
New York City

Blackboard fourth quarter revenue rose 35% to $85 million over the fourth quarter of 2007. Net income dropped by 33.3% to $3 million and earnings per share was 9 cents against 14 cents in the year ago quarter.

Blackboard, Inc. ((BBBB))
Q4 2008 Earnings Call Transcript
February 4, 2009 4:30 p.m. ET

Executives

Michael J. Stanton – Senior Vice President, Investor Relations
Michael L. Chasen – President & Chief Executive Officer
Michael Beach – Chief Financial Officer

Analysts

Michael Nemeroff – Wedbush Morgan Securities
Thomas Roderick – Thomas Weisel Partners
Scott Berg – ThinkEquity
Brandon Dobell – William Blair
Trace Urdan – Signal Hill
Gordon Lasek – Robert W. Baird
Bradley Mook – MKM Partners
Terry Tillman – Raymond James
Nitish Srivastava – Banc of America

Presentation

Operator

Good day, ladies and gentlemen and welcome to the Fourth Quarter 2008 Blackboard Incorporated Earnings Conference Call. My name is Misa (ph) and I will be your coordinator for today. (Operator Instructions) At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of this conference at which time you may press “*1” to participate. If at nay time during the call you require audio assistance please key “*0” and a coordinator will be happy to assist you. As a reminder this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today''s call, Mr. Michael Stanton, Senior Vice President, Investor Relations. Please proceed, sir.

Michael J. Stanton – Vice President Investor Relations

Thank you, Misa. Hello and thank you for joining us today for Blackboard''s fourth quarter and year-end conference call. I’d 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 including financial guidance for 2009. 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, and such other risks as described in the Risk Factors section of Blackboard''s most recent Form 10-Q on file 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 notes related to some of the metrics we will provide today. First, we will provide non-GAAP adjusted net income and non-GAAP adjusted net income per share on this call, as additional information regarding our operating results. These measures are not, in accordance with, nor an alternative for GAAP, and may be different from the 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 financial condition and results of operations. A reconciliation of GAAP and non-GAAP metrics has been provided in today''s earnings press release.

The second administrative note today relates to contract value, which we will also discuss. Our contract value represents the annualized recurring ratable revenue under existing contracts with clients in effect at the end of the quarter without regards to 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 have once again provided supplemental information related to licenses and contract value on the Investor Center section of the website at investor.blackboard.com. The document in question is titled Blackboard fourth quarter 2008 metrics.

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

Michael L. Chasen – Chief Executive Officer

Thanks Michael. Good afternoon everyone. We are pleased with our financial results for the fourth quarter and the full year, which were slightly ahead of our guidance, especially in light of the current economic challenges. Our financial success is largely attributable to our annual subscription business model, the value we bring to our customers and the relative resilience of the education market during difficult economic times. Revenue for the fourth quarter was $85 million, an increase of 35% over the fourth quarter of 2007, and slightly ahead of our guidance of $82.9 million to $84.9 million. Net income was $3 million or $0.09 per diluted share and non-GAAP adjusted net income was $8.9 million or $0.28 per diluted share for the quarter, again ahead of our previous guidance. Our cash flow from operations was generally inline with our expectations coming in at $24.4 million for the quarter. As we indicated last quarter, the slowing economy is having an impact on the education industry. For our business, this has led to longer sales cycles, delayed purchasing in back-end loaded quarters.

And, while the education industry is more resilient than others during difficult economic times as you are aware K-12 funding has been challenged and higher education institutions in both the U.S. and abroad are experiencing budget cuts as a result of the general economy and/or endowment losses. Despite these challenges, given the mission-critical nature of our technology, the ROI and the solutions we provide, our market leadership in all areas we serve, and the strong relationships we have with over 5500 educational institutions, we continue to expand existing client relationships and add new clients, achieve high renewal and retention rates and deliver on our financial guidance. In terms of our U.S. higher education market, we added a few new client relationships as well as expanded existing relationships with a number of institutions including The Community College of Baltimore County, Ivy Tech Community College, South Orange County Community College, and Wayne County Community College. All added our Managed Hosting offering to support their existing Blackboard licenses. As we have said in the past Managed Hosting provides a significant benefit to our client institution, as we were able to cost effectively provide 24x7 support and guaranteed uptime.

In terms of cross selling, we continue to see progress with the Blackboard Connect offering. In the quarter, The City Colleges of Chicago expanded their relationship with Blackboard by licensing the Blackboard Connect platform for the mission critical communication needs. This was a big win and the first win in Illinois following the state''s adoption of The Campus Security Enhancement Act. Finally, Florida State University became our newest client utilizing the Blackboard Transaction System for their campus commerce and security needs. This was a significant competitive win for us as they are one of the largest universities in the United States. On the international front, I would like to highlight Charles Darwin University in Australia was a significant win for Asia-Pacific region and represents our first sale of a Blackboard Outcomes System in this part of the world. We worked as a strategic partner with the Deputy Vice-Chancellor to identify institutional pain and then used the capabilities of the Blackboard Outcomes System to address institutional challenges and goal.

In the United Kingdom, Suffolk New College and Coatbridge New College were two important new wins, where we successfully differentiated our products and provisions from the other so called free open source competitors. Finally, Korea University became a new client licensing the Blackboard Learning System. This was a great win for us. Korea is a relatively new market and untapped for Blackboard and Korea University is a prestigious institution in the country with nearly 30,000 students. In K-12 our new sales included The Cherry Creek School district and Jersey City Public School, who both licensed Blackboard Connect. The Delaware Department of Education became the new client licensing the Blackboard Learning System, the Blackboard Community System and the Blackboard Content System. We continue to make good progress with various state departments of all departments of education and we will continue to focus on these important deals in 2009. And lastly Cincinnati Public School joined us as a new client and licensed the Blackboard Learning System, to power the school systems, Online Teaching, and Learning Program. For the year, we ended 2008 with 5,547 clients, which included 2015 North America Higher Education Institutions, 850 international clients, 2092 U.S K-12 entities and 590 publishers, commercial education companies, corporations, and government organizations. Moving on to licenses, we ended the quarter with a total of 6,817 enterprise category licenses.

Breaking out these licenses we had 2,382 licenses of the enterprise Blackboard Learning System, 869 licenses of the Blackboard Community System, 495 licenses of the Blackboard Content System, 32 licenses of the Blackboard Outcome System, 455 licenses of the Blackboard Transaction System and 2,584 licenses of the Blackboard Connect offering. In terms of the Blackboard Learning System’s basic product, we ended the year with 752 licenses. The total number of licenses including basic licenses at the end of the quarter was 7,569. In terms of our Managed Hosting business, we finished the quarter with 615 Hosting clients, which is an 18% increase over the last year. One note on our license metrics, as we indicated in late 2008 we will discontinue the practice of reporting all individual license metric at the end of 2009. As many of you have highlighted to us the increasing variability in licensing pricing makes it difficult to accurately model our business from an individual license unit perspective.

The most extreme example of this is in our Blackboard Connect offering, where we sell licenses in the range of $5,000 to as much as several million dollars per license. Given these dynamics, beginning in 2010 on a quarterly basis, we will only be reporting total number of enterprise licenses and average contract value of licenses. We will continue to report total contract value, total number of clients for marking average contract value per client metric at the end of each year as we have historically done. The company’s up-sell rate to our enterprise license to the Blackboard Learning System was approximately 13% in 2008. For the year, our renewal rate was 93%, which was higher than the 92% renewal rate we reported in 2007. As per contract value, we finished the quarter with an annualized contract value of $279 million. Average contract value per client was $50,300 and average contract value per license was $37,000 at the end of the fourth quarter. Our total headcount at the end of the fourth quarter was 1,087 people. We ended the quarter with 252 people in sales, 90 people in marketing and business development, 235 in product development, 200 in support, Managed Hosting, and production, a 135 in professional services; and 175 people in operations.

Now, before Mike Beach, our CFO comments on our financials, I want to close with some commentary about Blackboard''s sales and the general business environment in the fourth quarter and about our expectations and plans for 2009. As we finalize our budget and plan for 2009 and in turn our financial guidance, we started with a baseline assumption that the general business environment will be similar or in some cases slightly worse than what we had experienced in the second half of 2008. We also spent a significant amount of time with our senior sales management to provide us with insight into the sales landscape and their market. Based on this process, we currently believe that renewal, which represents approximately 75% of our renewals of our revenue stream, will be consistent with historical trends. As far as new sales in 2009, while we still expect to add a number of new customers, we expect a majority of our new sales that come from upgrading and up-selling our existing customers. Despite the overall economic challenges, we continue to believe that the education market is more resilient and we are well positioned to achieve strong revenue growth in 2009 due to several factors.

One, the products we provide are mission-critical and core to our client''s ability to deliver on their business. Whether it is to enable teaching and learning, manage campus security and commerce or provide mass communication services in critical situations, our technology is core. And in tough economic times institutions will invest in those core technologies. Two, our solutions have meaningful ROI argument that more than justify the cost of these solutions. Three, we are a market leader in all of the area that we serve. In economic downturns, institutions that partner with the leading companies that they know will be around to support them in the long run. And four, we have a large and diversified client base of more than 5,500 institutions onto which we can up sell and cross sell our solutions.

Additionally, there are other positive catalysts that could benefit our business. Let me discuss a few. As you know, we just recently launched the next version of our teaching and learning platform, Blackboard Learn version 9. This is the first major step in the development of the industry''s next generation e-Learning platform. Version 9 was made available for clients in late December. And we have already received a great deal of positive feedback about this product release. Importantly, it is a first release that we can expect some of the former WebCT client base to begin to upgrade to during the course of 2009. I think it is also worth highlighting some of the funding resources being contemplated for U.S.K-12 and higher education institutions. Many of you have asked us about Congress'' proposed education investments in the pending stimulus package and it is worth noting that significant dollars are being contemplated for education technology. We believe that many of our technologies could be well positioned in terms of state and federal funding that is currently being proposed.

There was also the possibility that federal funding could at least in part mitigate public higher education in K-12 budget pressure. However, due to the manner in which we expect the funds to be disbursed and spent, we believe that this opportunity could materialize over multiple years. If we turn to the bottom line, we also have taken a realistic approach to building expenses in support of our revenue growth objectives and will manage expenses closely throughout the year. Because of the predictability of our model, if the year proceeds differently than we have originally planned, we still have the visibility and the levers necessary to help ensure margin expansion. With that I will turn the call over to our CFO, Mike Beach to cover our financials and future guidance. Mike?

Michael Beach – Chief Financial Officer

Thanks Michael. I''ll organize today’s financial review around the income statement, the balance sheet, and cash flow, and close with the outlook and guidance for the first quarter and full year 2009. Revenue for the fourth quarter of 2008 was $85 million, up 35% from last year and slightly above our guidance. Product revenue for the quarter was $77.4 million, representing an increase of 35% over the same quarter of 2007. Professional service revenue for the quarter was $7.6 million, which represents an increase of 30% over the prior year. In terms of revenue characterization, we also break out our revenue by the nature of the revenue streams, which include ratable recurring, ratable non-recurring and other revenues. For the fourth quarter, ratable recurring revenues increased 40% to $69 million, as compared to $49.4 million in the same quarter of 2007. Ratable non-recurring revenues increased 23% to $6.7 million as compared to $5.5 million in the same quarter of 2007. Other revenues increased 11% to $9.3 million, as compared to $8.4 million in the same quarter of 2007 with service revenue being stronger than anticipated.

Moving onto gross profit, our gross profit for the fourth quarter excluding stock-based compensation and the amortization of acquired intangibles was $59.3 million, as compared to $47.1 million in the same quarter of 2007 representing an increase of 26%. For the quarter, our gross margin was 70% excluding stock-based compensation and amortization of acquired intangibles. Total operating expenses, excluding the cost of revenues, stock-based compensation and the amortization of acquired intangibles were $42.9 million for the quarter, representing an increase of 36% as compared to $31.6 million in the same quarter of 2007. For the quarter, we incurred stock-based compensation expense of $4 million and intangible amortization expense of $9.7 million. Our GAAP net income for the quarter was $3 million, compared to net income of $4.2 million in the same quarter of 2007. GAAP net income per diluted share was $0.09 for the quarter, compared to net income per diluted share of $0.14 for the same quarter of 2007. Non-GAAP adjusted net income excluding the amortization of acquired intangibles net of tax for the quarter was $8.9 million or $0.28 per diluted share.

In terms of balance sheet, we had cash and cash equivalents of $141.7 million at the end of 2008. Accounts receivable increased to $92.5 million from $52.8 million at the end of 2007. We did experience an increase in DSOs in the quarter as a result of the invoice timing, the impact of the NTI acquisition and slower than expected collections. Total deferred revenues increased to $184.8 million, up 43% from the $129 million at the end of 2007. Current deferred revenues related to our recurring products totaled $161.9 million at the end of 2008, compared to $111.9 million at the end of 2007, representing an increase of 45%. Moving onto cash flow, cash flow provided by operations totaled $24.4 million for the fourth quarter and capital expenditures were $1.7 million in the quarter.

Now, turning to the full year financials, for the full year ended December 31, 2008 revenue was $312.1 million, an increase of 30% over 2007. GAAP net income was $2.8 million for the full year of 2008, compared to net income of $12.9 million for 2007. GAAP net income per diluted share was $0.09 compared, to income per diluted share of $0.43 for the full year 2007. After adding back only the amortization of acquired intangibles, net of the associated tax impact resulted in non-GAAP adjusted net income of $25.7 million or non-GAAP adjusted net income of $0.81 per fully diluted share. Cash flow provided by operations totaled $79.8 million for the year, which represents a 15% increase compared to 2007. Before I provide guidance, I want to highlight a change in the definition of our non-GAAP adjusted net income and non-GAAP adjusted net income per share for 2009. Beginning in the first quarter of 2009, Blackboard will define non-GAAP adjusted net income and non-GAAP adjusted net income per diluted share to exclude the amortization acquired intangibles, stock-based compensation expense, and certain defined non-cash items all-net of taxes. Previously, we excluded only amortization of acquired intangibles net of taxes.

The drivers behind this change in definition are two-fold. First, we are excluding stock-based compensation from our non-GAAP results to better conform to our historic definition of operating margin. Additionally, this presentation of non-GAAP income is consistent with our broader peer group, which excludes stock-based compensation. Second, our exclusion of certain defined non-cash items, which added primarily to reflect items like the non-cash expense, we will record with the adoption of APB 14-1 in 2009 related to our convertible debt, which I will discuss in more detail after I provide guidance. In today’s press release, we have provided 2008 results in both our old definition of non-GAAP as well as our new definition of non-GAAP for your review.

Moving on to guidance, for the first quarter of 2009, we expect revenue of $83.5 million to $86.5 million, amortization of acquired intangibles of approximately $8.8 million, stock-based compensation expense of approximately $4.3 million. GAAP net loss of $1.2 million, the GAAP net income of $600,000 resulting in GAAP net loss per basic share of $0.04 to GAAP net income per diluted share of $0.02, which is based on an estimated $31.4 million basic shares and 32.2 million diluted shares respectively and an estimated effective tax rate of approximately 38%. Non-GAAP adjusted net income of $6.7 to $8.6 million, which excludes stock-based compensation expense and the amortization of acquired intangibles net of tax and non-GAAP adjusted net income per diluted share of $0.21 to $0.27, based on estimated 32.2 million diluted shares and an estimated effective tax rate of approximately 38.5%.

For the full year 2009, we expect revenue of $361 to $373 million, stock-based compensation expense of approximately $16.5 million, amortization of acquired intangibles of approximately $28 million, GAAP net income of $16.1 million to $23.5 million resulting in GAAP net income per diluted share of $0.49 to $0.72, which is based on estimated 32.5 million diluted shares and an estimated effective tax rate of approximately 38%. Non-GAAP adjusted net income of $43.7 million to $51.1 million, which excludes stock-based compensation expense and the amortization of acquired intangibles net of tax. Non-GAAP adjusted net income per diluted share of $1.34 to a $1.57, based on estimated 32.5 million diluted shares and an estimated effective tax rate of approximately 38.5%. Cash flow from operations of $80 million to $95 million and capital expenditures will represent approximately 6% of total revenue. As we look at cash flow for 2009, we are cautious given the macroeconomic environment. It is important to note that our cash flow from operations growth will be negatively impacted by higher cash taxes in 2009, which we currently estimate to be $10 million, as we will utilize most of our remaining net operating losses in 2009. In future years, we will not have the benefit from material net operating losses. The GAAP guidance we have provided does not include the adoption of APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion. APB 14–1 will result in an increase in interest expense on our outstanding convertible debt of approximately $1.5 million in the first quarter of 2009 and $6 million for the full year.

Just to clarify, the adoption of this new standard will have no impact on our non-GAAP earnings as the additional interest expenses, is a non-cash expense, which we will exclude from the non-GAAP calculation under our new definition. And one last comment, before I turn the call over to Q&A. Our guidance at the mid-point reflects a 23% EBITDA margin excluding stock-based compensation or slightly more than 200 basis point expansion year-over-year. This clearly shows that even in tough economic times, our model continues to deliver material operating leverage. That concludes the discussion of Blackboard''s financials.

Now, let me hand it back to Michael Stanton for closing. Michael?

Michael J. Stanton

Thanks Mike. We plan to be at the Thomas Weisel Technology Conference and the Deutsche Bank Small and Mid-Cap Conference next week and the Credit Suisse Global Services Conference at the end of February. And we look forward to spending some time with our investors. Operator, that concludes our formal comments and we are ready to begin the Q&A.

Operator

(Operator Instructions) Ladies and gentlemen if you wish to ask a question please press “*1” on your touchtone telephone, if your question has been answered or you wish to withdraw simply press “*2”. Questions will be taken in the order received. Press “*1” to begin and standby while questions are compiled, your first question comes from the line of Michael Nemeroff with Wedbush. Please proceed.

Michael Nemeroff – Wedbush Morgan Securities

Hi guys thanks for taking my questions. Very nice quarter by the way, a quick question for Mike Chasen, and then one quick follow-up for Mike Beach. Mike Chasen, I know you guys are typically pretty conservative and usually report results for the full year above the high-end of your guidance range to give for the year. But what makes you so comfortable that you will be able to make your 2009 targets, given the environment specifically the issues many schools are having with their budgets given the large losses and endowments. And the same question I guess with respect to the K-12 markets as a result of the declines in local and state tax receipts?

Michael L. Chasen

Sure, let me try addressing that actually in two ways. First, when we were looking to build up our budget on 2009 we relied not only on the historical performance of the last two quarters, which we thought represented some of the more turbulent economic pressure that we are seeing in the market, but also by working very closely with our sales leadership and management to take a look out in their respective markets and get a sense of really what was happening on the ground with our client. So, all of that contributed to building up our model for next year. At the same time, as I mentioned in my prepared remarks our renewal base is just right around 75% of our overall revenue. So, that allows us to right at the beginning of the year I think, have a good amount of visibility into what our performance can be for 2009. The second point I would like to make is that even though institutions are facing more economic pressure, the solutions that we deliver are truly core to what they''re doing whether its our teaching and learning solution. It allows them to supplement their traditional classes with traditional course material online or full distance learning online, but there is our Blackboard Transact Solution that allows them to provide campus security and commerce. But it is our Blackboard Connect Solution that allows them to recount the entire constituency all the students and faculty in a matter of minutes if it got to an emergency situation, would all be listed as either mission critical or some of the most important applications on a campus and core fundamentally to what they do. So even if these are clients certainly these institutions are facing economic pressure, our products are often at the top of the list with their priorities and in fact are enabling them to actually perform the business that they are in on the daily basis. And we think that that helps provide a little additional protection from any downward economic pressure.

Michael Nemeroff – Wedbush Morgan Securities

Great and then just if I may one quick follow-up for Mike Beach, Mike in which areas are you expecting or which line items specifically you are expecting to generate the leverage to get the 200 basis point margin improvement plus that you''re guiding to?

Michael Beach]

Yeah. So, I think we are looking to get leverage kind of across all of our line items. Gross margins, we expect to get about a 100 basis point expansion there and I think the best way to think about the margin this year is, they will actually drop down a little bit from Q4 to Q1, because we did such a strong service quarter in Q1. So, they will drop down and then ramp up throughout the remainder of the year and then operating expenses we expect to get leverage across all of our OpEx line items during the year.

Michael Nemeroff – Wedbush Morgan Securities

Thank you very much. Nice quarter guys.

Michael L. Chasen

Sure, thank you.

Operator

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

Thomas Roderick – Thomas Weisel Partners

Hey guys, thanks and good afternoon. So, Michael you referred to some funding resources as certainly a positive catalyst and I was hoping you could just go into a little bit more detail around some of the opportunities in the stimulus package that was just laid out. Which products do you think can benefit the most and if you can offer us any sense of timing as to when you can potentially bid for some of these grants and when they might show up in the model if they ultimately do? How should we think about the timing on that? Thanks.

Michael L. Chasen

Sure, for the first part of that let me actually have Michael Stanton who handles our relationship from that end talk a little bit about the specifics of the stimulus package and then I can address some of the other questions of how our products relate, Michael?

Michael J. Stanton

Sure, Tom so, we have been following very, very closely the developments that have been going on in both the House and Senate versions of the stimulus bills since about mid December, and it''s a very fluid process that the House version came through and I think in total the House version was about a 170 billion in K-12 and U.S. higher education and workforce development. Now, there are some pockets of that that are very specific to education technology. The House version had $1 billion for education technology improvement. It had $250 million per state in grants, in that in grant money for state wide education data systems, analytics, and tracking. And then across both K-12 and higher education depending again on which version you are looking at the House or the Senate, anywhere from $3.5 billion to as much as $16 billion for those respective markets. In terms of incremental funding, now lot of that’s going to go into infrastructure, and stores, and electrical wiring and everything else. But we''ve been throughout the language of all of those line items, each specific language related to software and technology enterprise technologies, emergency notification. So, where do we think we could benefit? We think that there is potential to benefit. I mean there is specific line with their technologies that enhance student''s ability to learn or a teacher''s ability to teach. So, we think that our various learning applications are relevant. There is language in there related to emergency notification, communications, emergency preparedness. Campus commerce security to the extent that people are using these funds to build buildings and what not could be a possibility for the transaction system. Now, I’m not trying to oversell this. This is a long way from complete and if you watch the headlines just really in the last 24 hours, the Republicans have proposed a much different stimulus bill and the funding is not as great, but in the balance we believe that education is going to be important. The new Secretary of Education, Arne Duncan just came out in The Chronicle of Higher Education with a pretty detailed interview about investments in education driving the economy, driving employment, and that is the ultimate goal whether it''s the House or Senate, Democrats or Republicans they want to drive these things. So, we think that education is going to benefit. In turn, hopefully Blackboard can be a part of it, help stimulate some things, help with workforce training, help teacher’s ability to teach, things of that nature.

Thomas Roderick – Thomas Weisel Partners

Okay, that that’s great detail, a quick question for Mike Beach here. Just in terms of the guidance that you’ve laid out, it seems as though you guys are putting a little bit of a tough position because you have to say your annual guidance even though it’s sort of in the middle of the budget cycle for many of your customers, who from an education standpoint have their fiscal year end in June. So, can you give a sense as to what their, what you''re seeing in the mid-cycles of their budgets? Are they exiting their budgets, then you’re still seeing plenty of strong demand for the core and the up sell products? And then if you just add on that and address the contract value issue, I wasn’t quite sure I heard what you said, but just in terms of the not a redefinition, but how you’re going to be laying our contract value going forward if you could just repeat that that would be helpful? Thank you.

Michael Beach

Yeah, we will certainly. Look, as we speak with our partner institutions to understand their own budgeting process and cycle, a lot of them are talking to us upfront because, as they’re doing their longer-term planning, they want to make sure that they are appropriately budgeting for any whether it’s a pricing adjustment or additional software purchases to fit in with their long-term strategic initiatives. You have to understand and I know that Blackboard is often referred to as a enterprise software company, but our software does not cost millions of dollars like many of other enterprise software companies. As we mentioned, our script for average client is paying us right around $50,000 a year. So it''s a pretty small budget item and whether they have been purchasing another module that may add even 10% or 20% on top of that. It''s a relatively small amount to make sure it gets in the budget. So we have a pretty good amount of confidence that our products are not being removed from the budget and then as we are talking about longer-term strategic initiatives at the school that there is room to continue to up-sell and cross-sell.

Michael L. Chasen

I think clearly as we went through the budgeting process and Michael touched on this, we spend a lot of time with senior sales management, who are the folks, talking to the clients, understanding their budgets and clearly yeah there is budget, there are being budget cuts, there is mid-cycle cuts that are occurring. People are building up their budgets now and that’s…I think that was the best way for us to get the most accurate information as to what the market is now, and what the buying appetite is going to be throughout the year. So, we really focus that more than historically on kind of pushing our sales force to provide the information and provide us numbers that they thought they could deliver. You mentioned a possible change in the definition of contract value, which I think in and we are not changing the definition of contract value. So, I may have misheard your question, but…

Thomas Roderick – Thomas Weisel Partners

Okay. Maybe I misspoke but just are you going to be changing the way that you report contract value I think I just misheard…

Michael L. Chasen

No, the change we are making is with non-GAAP earnings. So, in our non-GAAP earnings, we historically excluded amortization expense net of tax. Now we are going to exclude amortization expense and stock-based comp and certain non-cash items net of tax. As you know we have always given an operating margin that was that excluded stock-based comp, so we feel like the earnings number is more appropriate. I think it''s still with that operating margin.

Tom Roderick - Thomas Weisel Partners

Okay. So, we will still get contract value every quarter here then?

Michael L. Chasen

You will.

Tom Roderick – Thomas Weisel Partners

Okay. Thank you.

Operator

Your next question comes from the line of Scott Berg with ThinkEquity. Please proceed.

Scott Berg – ThinkEquity

Hi guys. Nice quarter. Thanks for taking my questions here.

Michael Beach

Sure.

Michael L. Chasen

Sure. Thank you.

Scott Berg – ThinkEquity

Just a couple of quick ones, first of all, on the product side, with the, with kind of only training sales cycle recently, which products would say have been affected more or less given the current macro? Are you seeing less or more of that sales lengthening in one product versus the others and kind of across the board?

Michael L. Chasen

I would say that the dynamics were different across the board. It actually varies across all of our products as well as the market, so just a little bit of a change in the overall dynamic.

Scott Berg – ThinkEquity

Okay. And are you finding it easier to make up sales into your existing client base currently versus new sales or that slowdown was pretty consistent across both groups?

Michael L. Chasen

No, I would anecdotally say and I want to be careful here because it’s not a huge amount of historic data process referred to, but I would say that certainly the up sells and the cross sells are probably continuing to go at a quicker pace. We are seeing more opportunity there than completely new clients and you have to understand of course we have contracts with existing clients, we have relationships with them. So that it’s going to by definition make the sale easier and that just not selling new products, but upgrading to hosting as well. So, we would say that that''s going a little bit easier than sales to new clients, which might be slowing down a little bit more comparatively, but again that’s all kind of anecdotal.

Scott Berg – ThinkEquity

Okay. And my last question is regarding the purchase accounting for the NTI acquisition. It’s unless that deferred revenue right now occurring in the first quarter, I believe.

Michael Beach

There is a tiny amount that''s highly immaterial that hits in the first quarter. So, really all the purchase accounting has played through for NTI at the end of the quarter, fourth quarter.

Scott Berg – ThinkEquity

Okay, great. That''s all I have to understand. I will get back in the queue. Thank you.

Michael L. Chasen

Great thank you.

Operator

Your next question comes from Brandon Dobell with William Blair. Please proceed.

Brandon Dobell – William Blair

Thanks, couple of questions for you. As you''ve gone through the last quarter or so, any change in how you guys are discounting or not discounting for new deals or on renewals that are going through? Are you seeing anything in the kind of current environment that would cause you to believe that you have to discount more to get those deals done here in early ’09?

Michael L. Chasen

No, right now we have continued to apply our standard policy and practice and had not had a discount deal significantly to bring them in the door.

Michael Beach

Correct. I would say our new sales discounting is consistent with what we''ve done in the past, so nothing significantly different then what we have experienced.

Brandon Dobell – William Blair

Okay. On the hosting opportunity, a nice full up-tick in the number of clients, maybe some color on how much from Q3 to Q4 were those new clients that were hosting or going back into your existing pool of people and they are switching over to hosting and any kind of commentary on the average hosting deals that would be helpful too?

Michael L. Chasen

Sure, I think I can comment on that more broadly. I wouldn’t be able to specifically talk about just the Q3 to Q4 growth, but I can say that in general we are seeing more and more of our existing clients move to our hosting infrastructure, and that''s a larger and larger part of that number and you have to understand the reason why. We have institutions that are achieving such levels of success with their learning product that it becomes harder for them to manage onsite and we can provide not only a better infrastructure with better support for those with us and this has become so much critical for them it really becomes almost a priority for them to move it over and host it with us. At the same time, there is potential cost savings for the school. They get a good ROI moving over to our hosting facilities because they are able to not only see up their own hardware again. But we are able to leverage a larger infrastructure because there are number of hosting clients, but our staff is professionally trained in managing these type of applications, or are more effective at delivering their source as well.

Brandon Dobell – William Blair

Okay. And then two housekeeping questions, sales headcounts at the end of year and then maybe a quick comment on the year-over-year change in the international client count? Thanks guys.

Michael Beach

So, the quarter reps at the end of the year were 90.

Michael L. Chasen

As far as international, the change in license, there are two items affecting that. One is the natural progression that we see as clients that might have multiple basic license upgrade to a single enterprise license. At the same time certainly we are starting to experience what we saw in Q3 and Q4 is a little bit disappointing to us with regard to our performance in international. We actually made some slight adjustments to our staffing plans with regards to those regions. So we think that we have some good promise there for next year, for those two items contributed directly to I think our license in unit counts.

Michael Beach

Yeah, I think clearly we never want to lose clients, but I think the trend, which generally what we''ve kind of experienced broader across Blackboard, which was we had attrition of low priced customers. At the same time we were adding higher priced customers. So, the overall dynamic, the overall impact on contract value is positive but from a unit cap I think we had enough to cover the losses.

Brandon Dobell – William Blair

Okay, thanks guys.

Operator

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

Trace Urdan – Signal Hill

Hi good afternoon. I wonder if you could comment on the variability in the guidance on the revenue side and on the earnings side. So, as you look at the growth you are anticipating for next year, sort of what are the over and under cases based on? Is it, it sounds like maybe you are more secure about upgrades, and maybe less secure about new license sales. I don’t want to put words in your mouth, but maybe you could comment on that and then I’m wondering in terms of the there is a much wider divide it seems on the income side and how you’re thinking about the variables on that side of the equation? Is it just about whether there is project spending you’re able to do or not able to do or are there sort of certain factors that you’re looking at that might affect that?

Michael Beach

Yes, Trace I think the as you look at kind of the way we build up the guidance, clearly there is the renewal revenues, which is going to be the bulk of our revenues and, our assumption there are that renewals are going to be within kind of historic norms. The rest of the revenues relate to new sales. So it’s going to be new sales of product or new sales of services and obviously the range which we provided is going to account for more or less new sales. We believe the renewal numbers are pretty well fixed.

Trace Urdan – Signal Hill

And how much pricing is built into that?

Michael Beach

So, it''s consistent with what historically we’ve shown 4% to 5%.

Trace Urdan – Signal Hill

Okay. And then so on the sort of product versus service fee, do you feel like there is more or less risk around service revenues then because of the economy or is that sort of equally spread between product and services there?

Michael Beach

Yeah, I think we’ve spread the risk I think relatively, equally obviously from a quarter perspective next quarter perspective. Our greatest risk is service revenue because it’s recognized upfront, but one thing we did see in the fourth quarter was very strong service sales and revenue. So, that makes us probably more optimistic on the service side as we look out at 2009 than we originally would have been.

Trace Urdan – Signal Hill

Is that may be a little different from what you were thinking at the time you were giving us guidance heading into the quarter. Did you think may be service revenues were little bit more at risk?

Michael Beach

Yes, yes. I mean clearly services to some extent a discretionary spend for some of our clients, and I think as we gave guidance for the fourth quarter we were more cautious. Pleased to see, kind of the results of fourth quarter, and a lot of concentration of the company and the company’s management are focusing on service sales and delivery. So, the services, clearly is a risk next year. Obviously it’s our biggest up front revenue recognition, but the trend in the fourth quarter was positive.

Trace Urdan – Signal Hill

And then to the sort of the second part of the question with respect to the spread on the income side, is it, would I be assuming too much to think that you were potentially holding back on spending until you get a better sense of how the year shapes up and may be that accounts for some of the variability there?

Michael Beach]

Yeah I think, you''re thinking about this correctly. We are back-end loading expenses and buildup from an expense perspective, a fairly appropriately conservative budget where you are not going to see OpEx increasing substantially quarter-over-quarter.

Trace Urdan – Signal Hill

Got it, great thank you.

Operator

Your next question comes from the line of Gordon Lasek with Robert W. Baird. Please proceed.

Gordon Lasek – Robert W. Baird

Hi thanks a lot. I wondered if you could comment on enrollment trends within your client institutions given the downturn in the economy and as more people go back to school. Is that having a positive impact on your revenue stream? How should we think about that?

Michael L. Chasen

Sure, it actually affects different segments of our business a little bit different. So, let me go into a little bit more detail. Certainly as I am sure you aware as unemployment goes up more people actually go back-to-school. The institutions that benefit from that specifically are both community colleges as well as commercial education providers. Those are also two subgroups. They get the majority of their revenue from tuition. So community colleges as well as commercial education providers often look to work to expand the amount of students that they are taking in and put more courses online and you see the success with some of the commercial education providers. One of our key clients Bridgepoint for example as well as Capella, we believe it''s starting to see increasing enrollments because of the strength and look to utilize technology particularly Blackboard technology to be able to handle that additional influx of students while also being able to manage the faculty and try to keep expenses down.

Gordon Lasek – Robert W. Baird

Thanks for the color there. And then just real quick, can you give us the contribution from NTI in the quarter?

Michael Beach

At the time we acquired NTI we essentially combined all of our sales forces and operation so we don’t breakout the NTI results.

Gordon Lasek – Robert W. Baird

Okay. And then one final question just housekeeping, has the New Mexico deal gone live and have you begun recognizing revenue from that deal?

Michael Beach

Yeah New Mexico went live in December and we got a little bit of revenue in quarter from that transaction.

Gordon Lasek – Robert W. Baird

Thanks a lot.

Operator

Your next question comes from the line of Brad Mook with MKM Partners. Please proceed.

Bradley Mook – MKM Partners

Thank you. Hi guys, on the difficultly of securing new customers I am wondering what kind of feedback you are getting on a couple of things. One, are any of them is it an issue of we don''t have the money right now. So we are going to put off the purchase or any of them looking for cheaper alternatives or workarounds that might preclude purchase of a Blackboard system down the road?

Michael L. Chasen

Yeah okay, I want to be careful. I don’t want to necessarily frame this as ‘absolutely we are having problems with new clients.’ So anecdotally I think what we are seeing is we obviously have relationships with over 5500 institutions already. Those institutions we already have contracts with and relationships with. So, just by definition the sales cycle for those institutions is going to be easier than a sales cycle to a new institution. Now at the same time now I think your question raises a good point, which is that institutions as they are now possibly either coming near the ends of their budget cycle or prepare for the next budget cycle are being more cautious, which also go to why we are seeing slightly longer sales cycle. But, I’d say that especially in these times when institutions are looking to purchase software technologies code, what they do like teaching and learning like security and commerce or like mass communication, they actually look for a company that they know is going to be around through these hard times and can be the partner for the long haul, and since we are a market leader in all these fields of institutions across the board are usually talking to us about their products. So, I’d say specifically they are trying to weigh or compete at lower priced products. Again I’d say that it has to do with more of just our own budgeting cycle and the relationships we now already have with the clients.

Bradley Mook – MKM Partners]

Okay. And then across new and existing, how volatile is the budget cycle? You mentioned some mid cycle budget cuts and obviously there is some sensitivity with respect to upcoming budgets being put into place, but how quickly does it change? Does it change within weeks, is it months, quarters I mean are you, I guess how is the time?

Michael L. Chasen

I would say really weeks and months. Yeah I mean just to add a little bit more color I mean across higher education take one market. I mean we''ve seen everything from 5% to as much as 20% budget cuts across the board at the extreme. Some of those is 5% and then there is a way that institutions can callback. I mean we have seen some interesting things across, public universities and decisions that they are making on the budget side. K-12 has been challenging in pockets similarly. But I also again want to go back to looking at the overall value proposition that our products bring to the market versus the price that we charge. When these budget cuts are taking place institutions are often looking at where they can save or cut back millions of dollars. Usually our products, which on average our clients are paying $50,000 a year it doesn’t quite meet the threshold to come to their attention if they’re having to work through significant budget cuts especially for the value that we deliver to the institution.

Bradley Mook – MKM Partners

Understood, okay and then, just the other question is in terms of the K-12 customer base, you gave the client numbers annually. Can you give us a number in terms of how can I phrase it, what I am looking for is the number of K-12 customers that are not using Connect and how that would have changed from last year.

Michael L. Chasen

Yeah, I mean we don’t break it out, but I mean I would say just directionally that the vast majority of new K-12 buyers are going to be on the Connect side.

Bradley Mook – MKM Partners

Right, yeah, I figured that much. I was just trying to get a sense in terms of what kind of progress or trying to get a precise effect of Connect in terms of new ads and cross selling and things like that, but if you don’t want give that number, I will have to do. Okay, thanks.

Michael L. Chasen

Thank you.

Michael Beach

Thanks Brad.

Operator

Your next question comes from the line of Terry Tillman with Raymond James. Please proceed.

Terry Tillman – Raymond James

Yeah. Good afternoon guys. Thanks for taking my questions. The first question is just related to, has there historically been a good correlation with your enterprise customers as they are upgrading that becomes a real hard flash point for them to be up to have cross-sell or up-sell and the reason why I asked that we talked to lot of the customers it seems like they are still on earlier versions not even on version 8 yet. So does that phenomenon provide some of your confidence the up-sell cross-sell remains relevant in ''09?

Michael L. Chasen

Certainly, believe all those are contributing factors and you are right just pointing out that a number of clients are on version 7 and the rest are on version 8. I mean that there is a big opportunity as they are now preparing to go to version 9 to also get in there an up-sell and cross-sell than the additional module. And also, let me be clear, version 9 is really the first version of our next generation of our e-Learning technology. So, more so than the difference of just going from 6 to 7 or 7 to 8 and this is a fundamental improvement in ease of use, the way they interact with the system, the ability to fully teach them online. So, one of the drivers that we talked about of momentum, we think we have with the next year, now we have just released the next generation of our software, already its creating a lot of good buzz for us in the industry even though its early. Now, the last comment I want to make on that is, you have to realize that institutions have limited windows at which they then look to upgrade. So, the majority of them will download the software and run it in a trial form early on, but then wait to upgrade to a specific time or break between the semesters. So, just as we have a new release, doesn''t mean everyone be rushing to it right away to migrate it whole school, but it does mean that they''re often talking to us, early on about those plans and that means that our sales and account people are in the door, they''re talking to them about their long-term strategies and how our products can help them.

Terry Tillman – Raymond James

And as it relates to version 9, do you have any customers that are in production? I know you had a beta program and I know you recently announced GA availability. I mean do you have production customers and could that actually be a potential catalyst in 2010 or it’s a helpful conversation, but it’s not necessarily a direct catalyst?

Michael L. Chasen

Yeah there are a small number of clients that are already in production with version 9, primarily from our beta program. Then, once we went live there, then they will fill their production environment. I think that you probably framed it right. In 2009, its probably a more of conservation, which is getting us from the door, but we probably expect to see more of the upgrades in 2010 and primarily you have to realize that a good portion of our install base is still is on the WebCT code of our Learning System and Blackboard version 9 and then the subsequent point releases is where we expect a lot of WebCT install base to migrate over to this new version of the product getting everyone on one code base as well as significantly enhancing their product and giving us the opportunity to better cross-sell and up-sell into that installed base. Certainly, though in 2009, it will help us in everything from new sales opportunities, where we can then showcase a better technology as well as in renewals of our clients seeing the road that we have laid out ahead for them and then getting excited to eventually move to that technology.

Terry Tillman – Raymond James

Okay. And then Michael Chasen last question just relates to, you had highlighted the mass messaging went in with the City of Chicago or Chicago Schools. Maybe could you talk a little bit more about? Was that a replacement and then as it relates to the mass messaging are you seeing more? Is it a replacement of first gen tool or is it more green filled when you win business? Thanks, nice quarter.

Michael L. Chasen

Yeah well thank you very much. I mean, look I want to be careful. All institutions have ways in which they can reach out to the entire student body. Certainly, schools can send everyone an e-mail. Does that meet the requirements of in an emergency being able to contact everyone, put an enrollment information. No, and certainly, if our solution is replacing something the school is currently doing, it is replacing it because we offer a significant amount of additional value to that institution. As far as the Chicago, I am not aware that they had any competitor system in there prior. I am not aware of that, but there is certainly a good chance that they had some previous way to do out to reach to their students that our system is now replacing. But a lot of the institutions that we are speaking to are just, and looking at Blackboard Connect, basically recognize that whatever they''re doing now does not meet the requirement, especially in these days of security and some are bigger issue to be able to reach out so quickly to the installed base, via phone, voice, e-mail, text and SMS messaging, which all our system provides, which is what we are getting in the door and getting a lot of sale traction there.

Operator

(Operator Instructions) As a reminder, press “*1” to ask a question, your next question comes from the line of Nitish Sri with Banc of America. Please proceed.

Nitish Srivastava – Banc of America

Thank you so much for taking my questions. Maybe you’ve already addressed this on the call earlier, but if I look at the gross margins on the product side year-over-year it’s about a 7% decline year-over-year. What’s causing this gross margins decline by 7% and how do I think about the gross margin going forward, especially on the product side?

Michael Beach

Okay. So, the decrease is going to be driven by the purchase accounting on the NTI transaction. So, there is $10 million that you would need to factor into the revenue number, which would bring up your gross margins more in line. I think as you think about a big picture after the NTI acquisition, the Connect business does have lower gross margins. So, that will net down the overall gross margin of the business a bit also now. The way, I think the way to think about gross margins this year as we look at, we are exiting 2008 with gross margin about 70% in the fourth quarter that''s going to drop down into Q1 because of lower service revenues and then it will ramp up throughout the remainder of the year probably exiting somewhere in Q4 in the 72% margin range, but the year-over-year gross margin should be up about a 100 basis points.

Nitish Srivastava – Banc of America

Gotcha, okay perfect and if I look at the customer count exiting 2008 there was a great ramp in K-12 presumably most of it or I don’t know what percentage was Connect, but if I look at more so on the Higher Ed side we added about 5%, the year-over-year increase was about 5%. I’m wondering how much more runway you have in terms of the market penetration especially on the Higher Ed side?

Michael L. Chasen

Sure, when you look at those numbers you have to recognize that we are in just over 2000 higher education institutions at about the 6000 as defined by the U.S. Department of Education in North America so, maybe about a third of the market or so. And certainly as we and as our sales force sells on bringing the part to market, they are focusing primarily on the schools that we already have contracts and relationships with. And especially in these harder economic times I think that''s more of their focus. So, we do expect to continue to see growth in the amount of institution across all of our markets, but obviously the majority of our sales are going to coming from existing relationships that we already have sales people and account managers with relationships there and we already have contracts in place.

Nitish Srivastava – Banc of America

Okay. And on the K-12 side of, for the new customer adds can you give us some kind of a color how much it was? How much of the new adds were just Connect or how much of it was just broad-based adoption of the learning system?

Michael Beach

Yeah. And we don’t break out this metrics, but I think in assumption that, that''s Connect of the majority of those, is the right way to look at it.

Nitish Srivastava – Banc of America

Okay, perfect. Thank you so much.

Michael L. Chasen

Sure. Thank you.

Operator

At this time we have no additional questions in the queue.

Michael J. Stanton

Misa thank you very much. Everybody thank you for your time today and we look forward to seeing you on the road or talking to you on our next earnings call. Take care.

Operator

Thank you. And thank you for your participation in today''s conference. This concludes our presentation. You may now disconnect. Have a wonderful day.