Blackbaud Inc (BLKB) 2012 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Blackbaud Third Quarter 2012 Earnings Conference Call. (Operator Instructions)

At this time, I would like to turn the Conference over to Tony Boor, CFO. Please go ahead.

Thank you. Good morning, everyone. Thank you for joining us today to review our Third Quarter 2012 results. With me on the call is Marc Chardon, our President and Chief Executive Officer. We both have prepared remarks, and then we'll open up the call for your questions.

Please note that our remarks today contain forward-looking statements. These statements are based solely on present information and are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements.

Please refer to our SEC filings, including our most recent Quarterly Report on Form 10-Q, our most recent Annual Report on form 10-K and the risk factors contained therein, as well as our periodic reports under the Securities Act of 1934 for more information on these risks and uncertainties and on the limitations that apply to our forward-looking statements. Also please note that a webcast of today's call will be available on our Investor Relations section of our website.

During this call, we will be referring to both GAAP and non-GAAP financial measures. We believe that non-GAAP measures are more representative of how we internally measure the business. A reconciliation of GAAP and non-GAAP results is available in the press release we issued today, which is available on our website at blackbaud.com.

With that, let me turn it over to Marc to review our high-level financial performance and business highlights. Then I'll come back at the end to provide greater details on our third quarter results as well as guidance for the fourth quarter and full year 2012.

Marc?

Thank you, Tony. And thanks to all of you for joining us today to review our third quarter results.

We delivered third quarter non-GAAP profitability that exceeded the high end of our guidance range in the face of a challenging economic environment. Our primary focus during the quarter was the integration of the Convio acquisition, and we made very good progress in a number of areas. Perhaps the most important for the long term -- after much work, we communicated the product roadmap decisions for our online fundraising and CRM offerings to our global sales organization and customer base.

As we look ahead, we're very excited to bring our best-of-both-worlds online and offline solutions to nonprofit customers of all sizes and across all verticals. And we've taken an important first step by defining the roadmap and becoming one integrated organization aligned to deliver on this potential.

Let me provide a summary-level review of our third quarter results. We generated non-GAAP operating income of $20.7 million, which was above our guidance of $18 million to $20 million, as we delivered combined company synergies at a faster-than-expected pace. Our non-GAAP revenue was $123.8 million, approximately $1 million below our guidance.

Our services revenue was shy of our target for the quarter due primarily to the integration of the Blackbaud and Convio Enterprise Customer organizations. With new ECBU leadership now in place and a strong pipeline of CRM opportunities, we're confident that we can improve our services execution.

Our subscription-related offerings faced economic headwinds during the quarter but still delivered solid performance and were the largest component of our overall revenue. Q3 was the first quarter to include a full quarter of Convio revenue, which significantly enhanced the scale of our subscription business. And we continued to shift traditional Blackbaud business toward subscription-based offerings.

The number of subscription-based units sold by Blackbaud overall now dwarfs that of [perpetual] units, and we continue to see growing demand for subscription-based pricing across all of our offerings, including the Raiser's Edge and the Financial Edge. We plan to further increase our focus on subscription-based offerings looking ahead, which we believe is positive for our business as it increases overall revenue visibility.

Turning to the business environment -- the Blackbaud Charitable Giving Index, which measures fundraising activity across a wide range of nonprofit organizations on a global basis, turned negative in the third quarter for the first time since 2009. This is a meaningful change from the low- to mid-teens growth experienced during 2011. While the increase or decrease of the Blackbaud Charitable Index is not a direct predictor of IT spending nor of our revenue performance, it does provide directional insight into the health of nonprofit organizations that make up our target market.

After a consistent period of business conditions improving, in the last six months we've seen an increase in the number of no-decisions. On the positive side, we still have delivered healthy growth in our subscription business, and our pipeline of opportunities remains strong. In addition, with the acquisition of Convio, we further expanded our competitive differentiation, scale and product portfolio. As a result, we believe that we're well positioned to gain market and wallet share in the $16.5 billion global market for delivering technology solutions to nonprofit organizations.

Now, let me take a few minutes to review each of our business units, beginning with our Enterprise Business Unit. We see significant long-term product replacement cycle getting underway in the enterprise segment of the market, where many of the world's largest nonprofit organizations are being ill-served by decades-old legacy systems that are not designed to meet the fundraising challenges of the 21st century.

Our solutions to address the enterprise market are -- Blackbaud's traditional CRM solution, which serves the largest and most complex organizations, as well as federated and international nonprofits; Blackbaud's CRM has generated over $130 million in bookings since it was launched five years ago; we're beginning to move Blackbaud's CRM down-market in the enterprise higher education and hospital sectors; we now have a second CRM solution for the enterprise market as we continue to invest in the Luminate CRM offering, which will serve cause and cure organizations in the mid- to lower end of the enterprise market, as well as nonprofit organizations, with a strategic focus on Salesforce.com.

When combined with our online enterprise solution, Luminate Online, we believe we offer the most comprehensive set of capabilities to serve the online and offline fundraising needs of [any] large nonprofit organization, offering a complete 360-degree view of an organization's constituents and allowing for the type of multichannel messaging that's essential for success in today's fundraising market.

During the third quarter, we closed four Blackbaud CRM deals, which is back in our historic target range of three to five deals per quarter. We did have the potential to outperform this level, but some sales cycles extended, due in part to customers waiting for more details on our enterprise product direction and due in part to our own execution.

We closed the third quarter by announcing our CRM and online fundraising product roadmap on September 30th at our Annual Customer Conference. As such, we began the fourth quarter with a very robust CRM pipeline, along with a clear product message that's been communicated to our global sales organization and the marketplace. Already, we're seeing Luminate CRM sales cycles start moving again now that we've confirmed our commitment to that solution.

From a longer-term perspective, we also believe the addition of Luminate CRM to our product portfolio will help us continue pushing down-market in the enterprise to drive greater volumes of CRM deals. This will help us improve the consistency and predictability of our Professional Services business when compared to staffing a smaller number of large multiyear projects.

In the General Markets Business Unit, we continue to see a pronounced shift toward sales of our subscription-based offerings. We view this as a positive for our business, both in terms of meeting customer demand for affordability and in the improved predictability and visibility we get from subscription revenue. The benefit of this mix shift is partially offset in the near term due to the timing impact of recognizing services revenue. When the business environment becomes more challenging, it typically first appears as an increase in no-decisions in smaller and midsize nonprofits, and we have again seen this in our General Markets Business Unit.

That said, our GMBU improved their ability to execute in a difficult market environment in the last recession, with a focus on flexible packaging and pricing to remove friction in the sales process and continue growing our business. I believe our General Markets business continues to execute well, especially considering the macro headwinds facing our target customers.

Our international business also performed well, given the well-covered macroeconomic backdrop throughout Europe. We believe the organizational and go-to-market changes that we've made in the business are helping us to muscle through the economic headwinds as much as possible, and they will position us very well for growth that is faster than our overall business as the global economy eventually recovers. As a reminder, we currently generate less than 15% of our revenue from our international operations.

I'd like to close with a very few additional words regarding the progress made integrating Convio and moving our Enterprise Business Unit forward. As discussed earlier, we achieved a major milestone during the third quarter by announcing our initial product roadmap to the market. This included making the tough but necessary decision to sunset Convio's Common Ground solution. This is not a decision we undertook lightly. But streamlining our product portfolio and eliminating duplicate products [will] better serve the nonprofit market and improve our operational efficiency.

We've made excellent progress in the cost front during the integration, and we're tracking ahead of our original target of $9 million to $10 million of annualized cost savings by the end of 2012. We believe there may be additional synergies to be realized going forward and are hard at work on delivering them.

We also built our management team during the quarter with the hiring of Joe Moye to run the Enterprise Business Unit. Joe joins Blackbaud with nearly 30 years of technology experience and has broad experience in enterprise sales, professional services and systems integration; most recently as the CEO of Capgemini Government Solutions. We believe Joe makes an already-strong team even stronger and that he's uniquely qualified to help Blackbaud structure and focus our resources to maximize penetration at both the high end and the low end of the enterprise market, so that we optimize sales of our solutions as well as the productivity and efficiency of our services organization. We very much look forward to Joe's contributions as he gets his arms around the business.

In summary -- we're still in the early stages of realizing the potential of our combined company following the acquisition of Convio. We exceeded our profitability guidance for the quarter due in large part to execution on synergies at a faster-than-expected pace. We also made important changes to our organization, leadership and product direction that we believe are already having a positive impact.

From a long-term perspective, we continue to believe that Blackbaud's ability to deliver best-of-both-worlds offerings to the market will drive significant market share gains. There's a lot of work to be done, but we believe we have a tremendous opportunity to build significant shareholder value over time.

With that, let me turn it over to Tony to review our financial results and guidance in more detail. Tony?

Thanks, Marc.

We're pleased with our ability to deliver non-GAAP profitability that exceeded our guidance range in the quarter as we made better-than-expected progress on realizing cost synergies for the Convio integration. At the same time, we are focused on improving our services performance and ensuring the organization is aligned for improved operational performance over the long term.

Let me now review our third quarter results. GAAP revenue was $122.5 million after adding back the $1.4 million deferred revenue right now associated with the Convio acquisition. We reported non-GAAP revenue of $123.8 million. This compared to $95.4 million in the third quarter of 2011 and was approximately $1 million below our guidance range, driven primarily by the shortfall in services revenue that Marc discussed earlier.

Non-GAAP subscription revenue was $48.3 million, an increase of 85%, compared to $26.1 million in the third quarter of 2011. Excluding the contribution from Convio, Blackbaud's year-over-year growth in subscription revenue was 17%, and the addition of Convio's contribution helped to drive our overall subscription revenue to a record 39% of our third quarter total revenue. The significant increase in our subscription revenue is a positive development, as it increases our long-term revenue visibility. And we will continue to focus on further increasing subscription-related sales as we move forward.

Maintenance revenue of $34.5 million for the third quarter was up 5% on a year-over-year basis. When combined with subscription revenue, our total non-GAAP recurring revenue was $82.8 million for the third quarter, which is an annualized recurring revenue run rate that is greater than $330 million.

License revenue in the third quarter was $4.5 million, compared to $5 million in Q3 of 2011. License revenue is inherently lumpy due to the relatively small amount of total license revenue that we generate, combined with the fact that our license revenue is composed of transactions that can often have long sales cycles and relatively large deal sizes. License revenue in the third quarter was down year-over-year primarily due to the timing of closing and recognizing revenue associated with our CRM offering.

Professional Services revenue was $34.9 million, compared to $29.6 million in the year-ago period. A significant majority of the year-over-year growth was due to the addition of Convio in the quarter, while the traditional Blackbaud services revenue was up several percentage points on a year-over-year basis. The shortfall in services relative to what was factored into our guidance was related primarily to our Enterprise Business Unit.

We believe the transition in leadership during the middle of the integration process led to execution challenges in the quarter. As we look ahead, we believe we are on the right track under Joe Moye's leadership and have a strong pipeline of opportunities that, once closed, would drive increased services work.

As I turn to our third quarter profitability, please note that the revenue percentages and the margins cited will be based upon our non-GAAP revenue and our non-GAAP expenses. On that basis, non-GAAP gross margin was 61%, consistent with the third quarter of 2011.

Consolidated non-GAAP operating income was $20.7 million, which represents a non-GAAP operating margin of approximately 17%. This exceeded our non-GAAP operating income guidance of $18 million to $20 million and was driven by good expense discipline as well as earlier and more substantial cost synergies from the Convio integration.

We're tracking ahead of plan on synergies and our $9 million to $10 million annualized cost-savings target. We are optimistic that we can find additional synergies during 2013.

Our non-GAAP diluted earnings per share were $0.26 for the quarter, which was $0.02 better than the high end of our $0.22 to $0.24 guidance.

Quickly summarizing our GAAP results for the quarter -- GAAP revenue was $122.5 million, operating income was $6.2 million, net income was $2.8 million, and EPS was $0.06. This compares to GAAP results of $95.4 million, $16 million, $10.2 million, and $0.23 respectively in the third quarter of 2011.

Turning to the balance sheet and cash flow -- we ended the third quarter with $25.6 million in cash and equivalents, an increase from $21.2 million from the end of last quarter. We generated $28.8 million of operating cash flow in the third quarter. Our unlevered free cash flow, which takes into consideration capital expenditures and excludes the impact of interest expense, was $26.8 million. This metric provides insight into what our cash flow for equity holders would be post paying down our debt.

We ended the quarter with $245 million of debt, down approximately $15 million due to payments made from our strong cash flow in the quarter.

I'd like to finish by providing guidance for the fourth quarter and updating our financial outlook for the full year 2012. For the fourth quarter, we are forecasting non-GAAP revenue in a range of $119 million to $121 million, which is down modestly from the $123 million in the third quarter. From a revenue mix perspective, we expect our services revenue to be down a few million sequentially due to the combination of seasonality -- as services work typically slows in the month of December due to the holidays -- and because of the previously discussed transition issues in our Enterprise Business Unit.

As we move towards 2013, we expect to see improvements in both Enterprise Services' gross margin and predictability under Joe Moye's leadership. In addition, the potential for improved services revenue beyond Q4 is certainly present based upon a strong pipeline of CRM opportunities that we are currently pursuing.

For our fourth quarter 2012 revenue mix, we also expect to see a sequential decline in the range of $1 million in our subscription revenue due to the fourth quarter being a seasonally weaker quarter for the usage component of our subscription revenue, particularly in legacy Convio business. We are forecasting non-GAAP operating income of $19 million to $20 million resulting in non-GAAP earnings per share of $0.23 to $0.24.

For the full year 2012, we are now forecasting total revenue in a range of $451 million to $453 million, compared to our previous guidance of $460 million to $465 million. From a qualitative perspective, we view the majority of the change in our forecast due to managing through the transition in our Enterprise Business Unit, with the balance due to the increased challenges presented by the macroeconomic environment. From a profitability perspective, we are now forecasting non-GAAP operating income of approximately $72 million to $73 million, which is within our previous guidance of $72 million to $75 million.

It's important to point out that our successful execution on realizing synergies during the acquisition integration process is expected to enable the Company to deliver profitability that is consistent with our prior view for the full year despite a top-line revenue reduction of approximately $10 million. During these uncertain economic times, we will continue to do what is within our control to protect the profitability and cash flow of the Company.

Below the operating line, we continue to expect interest expense of approximately $5.5 million for the year and a tax rate of 39%. This leads to a forecast of non-GAAP EPS of $0.91 to $0.92, which is again within our prior guidance range of $0.90 to $0.94.

To summarize -- we've made significant progress with the integration of Convio and believe the steps we have taken on the product roadmap, executive leadership and cost synergies front are positive steps to position our business for improved performance over the long term. It will take some time for our actions to impact our business and financial results. But we are protecting our bottom line in the meantime and believe we have significantly improved the Company's ability to capitalize on a $16.5 billion market opportunity, and to do so in a more efficient way as we scale.

With that, we're happy to take your questions.

(Operator Instructions) Tom Roderick, Stifel Nicolaus.

This is Chris Koh, in for Tom.

(Multiple speakers) our hands around the services commentary that you mentioned -- I think last quarter you had mentioned some of these enterprise CRM deals were taking a little longer than expected, and that kind of impacted the revenue recognition. And I think you mentioned this quarter there's a transitional issue; and that thirdly, I think you also mentioned, in the General Markets business, that there may have been some services impact there. So I was wondering if you could just clarify -- are all those three things issues? And what's your level of confidence that you can get those resolved, and over what timeframe?

Yes. The first was, to be clear, that were on track for bookings for CRM in the first half of the year, but that we'd had a smaller number of significantly larger deals compared to what we'd forecast. And so that meant that the run rate of services was going to be spread out over a longer period of time, because it's a smaller number of projects that would take a longer time.

And so that is not something that, quote-unquote, resolves itself; it's just something that means that the bookings that we got that were on track will happen over a longer period of time than they otherwise would have had. So that will have an impact this quarter, next quarter. And that was already considered inside of our guidance. So that's not a reason for the service under-performance this quarter or the drop in our expectations for services next quarter.

The second factor is that we had a slowdown in the bookings of our business that lasted longer as a result of, I think, the integration process, and also the bringing together of two sales organizations and two sales force automation systems, and so on. So we underperformed in bookings, and that will have a modest impact in this quarter, the quarter that just passed.

And it will have a larger impact in Q4. Because you don't really start the sales of services in the quarter that you [sell them] on the enterprise projects. So you might have a smaller impact in Q3 for deals that didn't close in Q3, and a significantly larger percentage impact in Q4. That also has an impact over time. Because until you get that deal back, you have -- once you get that deal back -- if it does come back -- you still have that same curve to go up.

And then, finally, we brought three different services organizations together during the third quarter. We brought the two Professional Services organizations of Convio and Blackbaud, plus our Managed Services business, and restructured them into vertical-oriented practices, if you will. And that meant that you were really bringing three different project management groups together and so on, as well as changing a lot of leadership there. And so, the amount of work that we actually did was impacted because of the confusion or the problems that came out of that integration process.

I'll mention, by the way -- I said that we missed some sales in the quarter -- part was roadmap-related, and part was execution-related in the missed sales on the second part.

So that may be a longish answer, but I wanted to give you the way to think about it. Does that help?

No, that's very helpful.

So just to clarify, in terms of -- and I know this may be a little bit hard to quantify, sorry -- but how much of the slow bookings was purely due to kind of integration execution, versus maybe an additional deceleration in the macro in the third quarter relative to the second?

I would say that the macro was very little to no impact in the enterprise side. If you take the Blackbaud traditional CRM product, I think it was more execution. And if you take the Luminate CRM side and the Luminate Online side, it was more roadmap-oriented.

All right. Excellent.

I think I'm good. Thank you very much.

Thanks, Chris.

Thank you, Chris.

Ross MacMillan, Jefferies.

The first question I had was actually on gross margins. I think this was a particularly strong quarter for the gross margin performance, both on subscriptions and also to some extent on services, at least sequentially. Can you just talk to what's driven the upside on the subscription gross margin? And how would you have us think about where that sort of should be on a run rate basis from here?

Yes, Ross. From a guidance perspective, we'll have to wait till next quarter, when we come out with some '13 guidance. But I would say, obviously we've got a lot of moving parts and pieces with the integration of the two companies.

Our performance overall from a profitability standpoint, which would obviously include gross margins, I would say, is largely impacted by our success on the synergy front. So while we've been wrestling a bit on the revenue side of the business largely associated with ECBU and services, we've been doing a phenomenal job obtaining the synergies that we expected.

And I think we mentioned in the prepared comments that we were ahead of schedule. We had stated we were hoping to get to a $9 million to $10 million annualized run rate by the end of this year; we believe we're ahead of that target. We expect that we'll see about $5 million of that $9 million to $10 million annualized run rate actually materialize in the year, in 2012.

And so, we've been managing what we can manage effectively, which is our cost structure, very, very closely. And I think that's what's driven a lot of the margin. And obviously, mix has some impact on the positive margins as well.

I'd make two additional comments, Ross. The Professional Services side of the house -- we continued to see a drop in non-billable work associated with the CRM projects that we've talked in the past. And so that was -- there's a significant down year-over-year and sequentially in Q3. And I would expect again to see an improvement, relative year-over-year and sequentially, in Q4 in terms of non-billable work.

Also note that the Professional Services part of the Convio business was relatively low margin. I don't remember if they gave the exact margin numbers, but I'm sure you're pretty much up on that. And so as we bring the organizations together, you can expect to see an improvement in sort of margin and across the overall portfolio based on mix.

The same thing is also true in subscriptions. Convio's subscription side was actually relatively strong in the gross margin space. So you've got a full quarter of Convio in Q3 which you didn't have in Q2, so that would -- there's just purely a mix shift inside subscriptions, in addition to the benefits that Tony was talking about, in terms of synergy line improvements in subscription costs.

So, just maybe to be clear -- the $9 million to $10 million of cost savings where you're running ahead of schedule -- those can be both in operating expenses and cost of goods?

Absolutely true.

That's helpful.

And then, Tony, could you just remind me how much of the subscription revenue is more transactional in nature? I know it's seasonal. If you could just help me kind of quantify that, that would be helpful.

Ross, give me just a sec -- see if we can look that up real quick. I don't have it handy with me.

And then, while you're looking that up, maybe a broader question, Marc. You're going through this process of consolidating down, if you will, the product portfolio and defining the roadmap. Just in broad terms, what do you think the product SKU -- the number of products, if you will, that you have -- what sort of magnitude of reduction are we going to see here as you focus your efforts on a more limited number of major products? Is it a 10% reduction in the total number of products you sell, or is it much larger than that?

Well, there are sort of two halves to your questions, Ross. The first is SKUs. And I think that during the period of time when especially the General Market business was really focusing on experimentation and tests on the package price and promote front, we actually had a lot of SKUs come out that were sort of mixes of products or mixes of products and solutions. So you'll see, I think, a significant reduction in SKUs that's based on package price and promote, as we take the learnings we've had over the past couple of years.

And so for any given vertical -- like the K-12 vertical, or like the arts and cultural vertical -- you're likely to see things focus down to a good-better-best as we move towards a subscription model and as we bring the product portfolios together.

In terms of the number of overall products, I don't have a percentage number to tell you, honestly speaking. But it's not a 50% reduction; it's a lower reduction. But that understates the simplification of the portfolio, and let me explain that.

For example, we had one CRM for the enterprise space. Now we have two. But we're going to focus the Luminate CRM on a subset of the market segment that's cause and cure, plus sales force committed customers. That means we don't have to engineer for those customers in the Blackbaud CRM product. So just because we have two products where there was one doesn't mean you have double the engineering. Because you're going to be reducing engineering on both products relative to the breadth that they would've had had you tried to take Luminate to the higher-ed space, or had you been trying to take CRM to the advocacy space.

Great. That's helpful.

Hey, Ross, this is Tony. That number on a combined company is approximately 20%.

And the quarters where it's more seasonally strong, if you will -- is Q4 the one quarter where it's seasonally weakest? Or could you just --

In usage revenue?

Yes, exactly.

Usage revenue -- Q3 is the highest -- in the usage sense, the Convio pattern has been that the events-oriented pattern is summer-oriented, because most events happen when Sandy's not hitting people. And from our perspective, our revenue quarter is typically -- we have, from the Blackbaud classic perspective -- Christmas is -- the end holiday season is the peak.

So the point, however, is that Convio's revenues on the transactional side were higher than Blackbaud's. There is a sequential decline from Q3 to Q4 of about $1 million in usage revenue that's based on that.

That's helpful.

And the lowest in the year of all, obviously, is Q1. Because neither Blackbaud nor Convio had a peak in the Q1 quarter.

That's helpful.

And then, one very last one, just as we look forward to your Q4 guide -- can you just remind me what you said -- I got what you had said on subscription, but how should I think about the services line going into Q4 relative to Q3 -- on the revenue side, I mean?

I think that what we've stated is that the impact outside of just normal seasonality -- the reason for taking our guidance down is largely, almost entirely, associated with ECBU and services. So I think you can equate the majority of any decline on the revenue side to that area.

After about $1 million decline in usage (inaudible).

Yes. Great. That's helpful, thank you.

In the Q4, you always have a challenge. Because you have Thanksgiving week, you've got the end-of-year holiday week. And there are a lot of organizations that don't want you to be working on their platform during the end-of-year push and blitz to get their numbers in.

And I think this year it's even more pronounced. Because many of these organizations are really nervous about whether the end-of-year numbers will be what they need them to be to finish the year well.

Yes, that's helpful. Thank you.

Thanks, Ross.

(Operator Instructions) Matthew Kempler, Sidoti & Company.

On the ECRM side, I understand the integration impact. But could you just review one more time what were the key execution issues, and have we already made the changes [in between group] performance there?

Well, the primary execution issues were just changes in leadership and changes in territories. When you take a new sales organization -- when you take two sales organizations, bring them together, there was always the question of whether it's the Convio classic or the Blackbaud classic person who ends up covering a given account. And so, we tried very much, if there was a deal in process, to leave the sales rep in place.

But those changes and the changes of people that they were reporting to -- and then the departure of Jean, and the change in sales VPs and sales managers -- I'm afraid that it's cause to be focused on some of those deals happening at the -- and so, for example, there's one that has come in already that slipped out of the quarter. We should've been above our range, had we done what we said we were going to forecast in the quarter. So it wouldn't have been twice the number of CRM deals, but we could've been at the five to six range, as opposed to the four that we had.

And so, I think that those things are actually pretty much behind us. Joe is spending his time visiting prospects and customers. And his sales reps know that he expects them every day to tell them where they are in their process. And you can even see that in terms of how early the contracting teams are getting involved and how all that is being pushed forward.

So I'm very comfortable that we've dealt with the execution issues on the sales side. I think that fixing the execution on the services side takes a little longer, because you have a larger number of systems, you've got a set of projects. And you also have just the fact that we didn't have the momentum in Q3 that would've filled the work pipeline in Q4 and Q1.

And then, I think, Matt, one other thing that we spoke about was a bit of the freeze in the market, more so on the Luminate CRM side, because we hadn't made the roadmap decision. And so we're seeing that starting to thaw now. But we did feel there was some freezing on the Convio side on CRM that -- hopefully, with our announcements at our Conference -- is thawing that out.

Yes, we've already had the first [MCRM] deal close as well, which is a good thing.

Great.

And then, on the subscription side of the business -- you mentioned that you're going to be increasing the focus there. Can you give us a sense of what does that mean? What are we going to be changing or offering more of on the subscription side?

Well, the primary thing that accelerates right now is that our customers for Financial Edge and Raiser's Edge -- a larger percentage of them are ending up with a subscription-based offering, even with a product that's [a hosted product]. And I don't have something specific to say about midmarket CRM yet. But when the midmarket CRM product comes to its full fruition -- it's probably 75% of the way there, if you will, for the higher-ed space -- there are organizations who really want to have that on a subscription basis as well. So I would expect midmarket enterprise to accelerate our move to subscription as you start to see some of that impact sometime in the first half of next year.

Okay. And are purely just offering existing products on a subscription model? Or are we also starting to convert our product to cloud-based platforms?

Well, cloud-based platforms are -- it's in the eye of the beholder, right? So if you have a virtual machine in which an RE runs, the customer doesn't really think of it very much differently than if it were a SaaS product, as long as they can access it online in the midmarket, for example.

So each of these products, as they go to subscription space, are being reengineered to be cost-effective to be in the cloud. And that takes some time. So that's part of why you've seen gross margin degradation in the subscription line. Because hosting an RE is more expensive than an ETAP multitenant application.

So what you'll see over time is improvement in gross margin, so reduction in cost of service delivery, for packaged products -- and over time, but in a longer horizon, will be moving to multitenant and/or fully hosted, not virtualized, environments. But that doesn't happen in an afternoon. So the margin improvement that's based on that will take time to achieve. But it's real.

And you compare -- it'll also happen as we move people from one product to another. So for example, in the enterprise space, you can see BB&C customers moving to Luminate Online over time to get into the broader range of features and functionalities and benefits that Luminate offers. Each one of those, actually, would reduce their hosting cost.

Okay, thank you.

Thank you. At this time, I would like to turn the call back to management for closing remarks.

Thanks, everybody, for joining us today.

Just to summarize, I'd say we've made significant progress in integrating Convio, running ahead of the cost synergies. We're focused on managing expenses and realizing those synergies as we move ahead in the integration process. And we're going to continue to make the judicious investments in the future of the business.

Macro environment is more challenging. I don't know which way it's going to go. We're looking for the end of the election, we're looking for what happens to the fiscal cliff. And we're looking towards the year-end fundraising results. They'll all have an impact, I think, on the buying attitude of our customers more in the midmarket than in the higher end of the market.

I'm very optimistic about the market opportunity. And as we bring the portfolio together, I think we've significantly strengthened our ability to offer multichannel fundraising and donor management-supported management solutions to our customers online-offline.

So that acquisition and integration of Convio has been a big asset to us in terms of the share of mind of our customers. And it's our job now to turn it into share of wallet for our customers.

I look forward to updating you on our progress as we meet throughout the quarter, and then at our next earnings call in February. Thank you very much.

Thank you.

And ladies and gentlemen, that does conclude our Conference for today. Thank you for your participation. You may now disconnect.