Oct 30, 2013
Executives
Brian Denyeau Anthony W. Boor - Interim Chief Executive Officer, Interim President, Chief Financial Officer, Principal Accounting Officer and Senior Vice President of Finance & Administration
Analysts
Tom M. Roderick - Stifel, Nicolaus & Co., Inc., Research Division Matthew J.
Kempler - Sidoti & Company, LLC Saket Kalia - JP Morgan Chase & Co, Research Division Ross MacMillan - Jefferies LLC, Research Division
Operator
Greetings. Welcome to the Blackbaud Third Quarter 2013 Earnings Conference Call.
[Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Tony Boor, Blackbaud's Interim President and CEO and CFO.
Thank you. Mr.
Boor, you may begin.
Brian Denyeau
Thank you, and good morning, everyone. Thank you for joining us today to review our third quarter 2013 results.
Joining me on the call today is Tony Boor, Blackbaud's Interim President and CEO and CFO. Tony has some prepared remarks and then we will open up the call to your questions.
Please note that our comments 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 recently -- recent quarterly report on Form 10-Q, our most recent annual report on Form 10-K/A and the risk factors contained therein, as well as our periodic reports and 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 for today's call will be available on the 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 on the press release issued today, which is available on our website at www.blackbaud.com. With that, let me turn the call over to Tony.
Anthony W. Boor
Thanks, Brian. Good morning, everyone.
Thank you for joining me today to review our solid third quarter 2013 performance. We delivered revenue of $128 million, which was in line with our guidance, and we generated non-GAAP operating income of $28.9 million, which was above the high end of our guidance and represents a non-GAAP operating margin of 22.6%.
As our results indicate, our business continues to perform at a high level, while our Board of Directors works to complete the process of selecting Blackbaud's next permanent CEO. In the meantime, I can tell you that everyone at Blackbaud is focused on the task at hand and we continue to work hard to build upon the improvements we've made over the last year to fully capitalize on market opportunity.
In my current role as Interim CEO, I have 3 priorities to advance Blackbaud's strategic initiatives. First is to build upon the progress we've made over the past year in positioning the company for improved long-term revenue growth.
Consistent with this objective, we've begun to increase investments in our product portfolio and our go-to-market organization to ensure we're properly positioned to capitalize on the future growth potential we see in the market. As we increase investments in these areas, it will clearly take time for them to positively impact our revenue growth.
My second key priority is to continue to streamline and rationalize our product portfolio, so that we are dedicating the proper resources to our highest growth, most profitable and strategic solutions. Exciting shift in the marketplace towards SaaS, online fundraising and mobile solutions, among others, require that we make the necessary investments to ensure Blackbaud remains the clear leader in the nonprofit software market.
This focused strategy is positive for our customers. It's the right thing for Blackbaud to do in order to maximize the returns on our R&D investments.
We introduced an important part of our product innovation during the third quarter with the release of Blackbaud Online Express, our new SaaS-based online fundraising platform that's also part of our longer-term strategy for streamlining our overall product portfolio. We also have additional exciting product introductions in store for 2014, including our new SaaS-based version of the Raiser's Edge that we'll talk about more in the quarters ahead.
Lastly, we will continue to focus on identifying new areas where we can improve operational efficiency, which we believe has the potential to free up additional resources that can be reinvested in sales and marketing and R&D. We're confident that the execution against these 3 objectives is the right strategy to optimize Blackbaud shareholder value.
The combination of the initiatives and the increased investments are expected to modestly reduce non-GAAP operating income margins temporarily in 2014 when compared to 2013 margin levels that are tracking ahead of our initial expectations. We have proven our ability to continually improve the operating efficiency of the company and we're confident that we continue to deliver in this area.
What is most important from of our view is that we take greater near-term action to drive increased revenue growth, while continuing to generate strong profitability and cash flow. I'll share more details later on how we see our strategies positively impacting Blackbaud's overall financial performance for the longer-term perspective, but first, I want to focus on the progress we've made against each of our initiatives during the third quarter.
We're pleased with our solid overall financial results, considering the macro environment remains challenging, albeit stable when compared to recent quarters. We've seen the Blackbaud Giving Index settle into the low-single-digit year-over-year growth range in recent months, and feedback from customers is that we are planning for modest growth and overall charitable giving to continue.
Positively, online charitable giving continues to grow at a double-digit pace and Blackbaud's best-of-breed fundraising tools and CRM platforms provide customers with all the tools they need to effectively generate contributions regardless of the method their constituents use to give. During the quarter, we hosted our Annual Users Conference, BBCON, which is the industry's premier nonprofit technology gathering.
We introduced exciting new solutions like Blackbaud Online Express, a SaaS-based online fundraising e-mail marketing solution that will make it dramatically easier for Raiser's Edge customers to begin running donor to list [ph] station campaigns within minutes. Blackbaud online express provides a significantly improved user experience, with intuitive drag-and-drop features and savvy dashboard metrics that extend the usability of our fundraising solutions to a wider group of users.
Our expectation is that, over time, Online Express will become customers' preferred online fundraising solution compared to several of our existing solutions, which represents a significant step forward in our product rationalization strategy. This type of innovation, which extends our existing rich product heritage with next-generation features and functionalities, is a key focus of our development efforts and will bring additional products like this to market in the future.
I'd now like to take a few minutes to review the performance of each our business units beginning with the enterprise customer business unit. ECBU had a solid third quarter.
And along with IBU, they signed a total of 8 deals across our CRM offerings, with customer such as Plan Finland, Plan Belgium and Plan Spain, among others. As these deals indicate, we had a strong quarter internationally with CRM deals and we're seeing high levels of customer interest in a number of our foreign markets.
Overall, we are optimistic about the pipeline of opportunities we are targeting at both the high and low end of the CRM market. We also had another strong performance in terms of go lives, bringing the 8 BBCRM customers live during the third quarter, including the University of North Carolina, Wake Forest University, the University of Georgia Foundation and Shriners Hospital for Children.
Two of our go lives were with international customers, one of which was Animals Asia. We continue to make progress in shortening the time it takes for CRM customers to go live, which further increase the time-to-value they generate from our products.
Luminate Online continues to be a market leader in our enterprise segment for online fundraising. We're also continuing to see opportunity for improved performance.
The feedback we received at bbcon and the product roadmap for Luminate Online and the breadth and depth of Blackbaud's product capabilities was a great validation of our strategy, reinforces our belief that we're addressing a significant enterprise market opportunity. Turning to the general markets business unit.
We had a solid performance overall, particular strength in our Financial Edge solutions. As you know, the mix shift towards our subscription offering has been occurring for some time, and this quarter saw a further movement in this direction with subscriptions outpacing license deals by 7:1 compared to a 5:1 ratio in the year-ago period.
The increase in mix towards subscription deals is being driven by products like Financial Edge where our sales are now entirely subscription based. We see customers embracing the ease of use and attractive economics of our subscription offerings, and our primary focus as a product organization will be to bring more subscription products to market over time.
We think this will increase our upsell and cross-sell opportunities inside our sizable installed base in the midmarket, and the growth of our subscription revenue helps to further improve the predictability and visibility of our overall financial results. Internationally, we had a solid quarter.
As mentioned earlier, we were seeing a good deal of interest in our CRM products in these markets, as well as continued growth of our Everyday Hero charity and consumer offerings. We have a healthy pipeline overseas for expanded offerings.
We feel very positive about the team we have in place executing against these deals. With almost 15% of our revenue coming internationally, we view growing our presence outside the United States as a significant long-term growth opportunity and see no reason why it would not represent a larger portion of our total revenue over time, especially if global economic recovery gains steam and that the nonprofit sectors in non-Anglo markets mature.
Before I move to the financial details of our third quarter, I wanted to note that we recently announced that Jana Eggers decided to step down from her position as Senior Vice President of Products and Marketing. Jana was a member of our senior executive leadership team for the past 3 years and I'd like to thank her for all her hard work and contributions.
We're fortunate to have a deep bench of high-quality management talent at Blackbaud and I'm confident our product organization will not miss a beat. At the same time, we are looking for ways to optimize our organizational structure to better align the company to deliver even better product innovation and customer service in the future.
Now I'd like to spend a few minutes reviewing our financial results for the third quarter and our guidance for the fourth quarter and the full year. Starting with the P&L.
GAAP revenue was $127.9 million and non-GAAP revenue was $128 million, compared to $123.8 million in the third quarter of 2012. Non-GAAP subscription revenue was $52 million compared to $48.3 million in the third quarter of 2012 and consistent with last quarter.
As expected, the recurring component of our subscription revenue grew sequentially, while a transaction component of our subscription revenue declined in a manner that's consistent with seasonal trends. Maintenance revenue was $34.7 million for the third quarter and up approximately 1% from a year ago quarter.
When combined with our subscription revenue, our total recurring revenue was $86.7 million for the third quarter, an annualized run rate of $347 million. License revenue in the quarter was $3.8 million, compared to $4.5 million in the year-ago period.
License revenue, which can be variable on a quarter-to-quarter basis, continues to become a smaller part of our overall revenue mix due to the growth in our subscription business. Services revenue in the quarter was $35.5 million, up 12% from last quarter and increasing 2% over last year.
We made additional progress in our third quarter, positioning of the services organization for improved efficiency as we move into 2014. Turning to profitability.
Non-GAAP gross margin was 61.2%, which was 30 basis points above the third quarter of last year. Our gross margin was positively impacted by increased scale of our subscription revenue base, which now represents 41% of our total revenue.
Non-GAAP operating income was $28.9 million and exceeded our guidance of $26 million to $28 million. Non-GAAP operating margin was 22.6%, representing almost 600 basis points of improvement from the third quarter of 2012.
Our better-than-expected profitability was driven by our improved cost structure and a greater benefit from the process improvements we've implemented in recent quarters to increase our operational efficiencies. Our non-GAAP diluted earnings per share were $0.37 for the quarter, which is $0.01 better than the high-end of our $0.33 to $0.36 guidance range.
Turning to the balance sheet and cash flow. In the third quarter, we generated $40.5 million in cash flow from operations, used $5.5 million to pay our quarterly dividend, invested $4.1 million in capital expenditures and capitalized software and used $28 -- $21.8 million to pay down our debt.
We ended the quarter with $173.7 million of debt, which is down from $195.5 million at the end of the second quarter. Our total deferred revenue balance was $194 million, an increase of 3% from the year-ago period.
I'd like to finish by turning to guidance, starting with the guidance for the fourth quarter and also providing some additional thoughts on our longer-term financial performance. We expect our fourth quarter non-GAAP revenue to be in the range of $131.5 million to $133.5 million and non-GAAP operating income of $24 million to $25 million, resulting in non-GAAP earnings per share of $0.31 to $0.32.
Please note that our fourth quarter revenue guidance reflects an approximate benefit of $5 million related to moving our Blackbaud merchant services revenue from recognition on a net basis to a gross basis, due to a change in how we're going to market. The regulatory environment has become more complex and our historic third-party payment processor made a decision to exit this business.
We now have a new partner, and under our arrangement with them, our responsibility for providing end-to-end merchant services over the course of customer transactions has increased. As a result, recognizing revenue on a gross basis is more appropriate as we move forward.
Accounting treatment aside, we expect our merchant services offering will continue to enjoy strong growth as it's a compelling solution for nonprofits, particularly as fundraising increasingly moves online. Also, included in our Q4 guidance are additional costs associated with the next phase of the infrastructure investments we're deploying to further improve our efficiency and productivity, as well as increased investments in sales and marketing and products that I touched on earlier, which are targeted at reaccelerating Blackbaud's revenue growth.
Turning to the full year. Based on third quarter results and fourth quarter guidance, our updated full year '13 revenue guidance is $501.5 million to $503.5 million.
This compares to our prior range of $498 million to $504 million. From a profitability perspective, we're now guiding to 20.0% to 20.1% for the full year non-GAAP operating margin versus our prior guidance of 19.9% to 20.2%.
This now represents approximately 330 basis points of year-over-year margin expansion at the midpoint. This translates in the non-GAAP EPS of $1.27 to $1.28, which is essentially the midpoint of our previous full year guidance of $1.26 to $1.30.
Now let me share some high-level views on Blackbaud's longer-term financial performance based upon the strategic initiatives I discussed earlier. As I mentioned earlier, we plan to increase investments in our product, sales and marketing organization to position the company for accelerating long-term revenue growth.
These investments over the next 12 to 15 months lead us to moderate revenue growth in '14 because our product initiatives are primarily focused on subscription and SaaS-based offerings and it takes several quarters for new sales and marketing investments to become productive. Taking this into consideration, as well as the overall giving environment, our current expectation is that we would generate mid-single-digit revenue growth in '14 prior to the change from net to gross revenue for the merchant services revenue.
If we add this related positive impact of approximately $20 million that we would expect to see as a result of this change, our current view is that our reported 2014 revenue will grow to upper-single digits compared to the midpoint of our 2013 guidance. 2013 has been a strong year from a profitability perspective, so we've been successful in controlling our spending while simultaneously making numerous revenue and product improvements.
We are early in our 2014 planning process, but we are anticipating that we will be balancing between investments for accelerated long-term revenue growth and continuing to streamline our cost structure. Our current expectation is that we will experience a moderate reduction in our non-GAAP EBIT margin as a result of our increased sales and marketing R&D investments.
We anticipate these investments will position Blackbaud for further acceleration in our revenue growth in the coming years. We're very mindful of the fact that we're spending shareholder's money to make these planned investments in '14 and we strongly believe that these investments will generate the most long-term value for our shareholders.
We're not yet giving formal guidance, but we would expect to do so in conjunction with our fourth quarter earnings release. In summary, our third quarter results demonstrated the continued progress we are making against our strategic initiatives.
In addition, we are taking additional steps we believe will improve Blackbaud's revenue growth and operational efficiency. We're optimistic of -- about Blackbaud's future and I look forward to updating you on progress and our outlook for 2014 when we report our fourth quarter results in February.
With that, I'm happy to take your questions.
Operator
[Operator Instructions] Our first question is from the line of Tom Roderick with Stifel.
Tom M. Roderick - Stifel, Nicolaus & Co., Inc., Research Division
First question here. Just in terms of some commentary you offered in the quarter surrounding subscription growth on the bookings front and I recognize it doesn't necessarily flow into the P&L right away, but you talked about GMBU subscriptions outpacing license deals by 7 to 1 and some nice impact for the enterprise side.
Can you provide any, maybe, qualitative direction as to sort how of the bookings flow has been pacing relative to your expectations? And from that standpoint, if there's an area where you could look to improve or you think there's room to improve.
Would you point it more on the GMBU side or on the enterprise side?
Anthony W. Boor
From a subscriptions bookings growth perspective, I would say that performance has been tracking in line with expectation. The opportunity is certainly significant.
As you know, we had a bit of a hit last year after the Convio acquisition and a bit of a freeze in the market as a result of us trying to roll out the product roadmap decisions and make some of the decisions we did on product rationalization. And we're still digging out of that one a bit this year and the impact, but as we said over the last couple of quarters, the pipeline has refilled fairly well on the Convio products.
We've done very well as with our offering FE. FE now, Financial Edge, for us is offered wholly in subscriptions within GMBU.
So we're selling, I believe, those have -- we've eliminated perpetual sales on FE at this time. We're looking at continuing to migrate towards that similar type of offer for RE in 2014.
So we would expect to see some additional headwind as a result of that change, although we've done pretty well working through the FE change. Demand has been good.
We've seen more unit sales as a result of shifting to that subscription-hosted offering on FE. So, all in all, I would say, expectation is very positive on the shift to subscriptions.
The -- as you know and as you work through the models that ratable recognition and related timing has a bit of a drag on the revenue growth in the short-term and that's part of what we're building into our initial thoughts as far as 2014, is a more accelerated shift towards subscription, not an all-out shift, but a continued acceleration in that shift, and that's going to be a drag in the near term but should be very positive for us in '15 and beyond.
Tom M. Roderick - Stifel, Nicolaus & Co., Inc., Research Division
Great. Maybe following up on the commentary around Raiser's Edge.
You talked briefly about rolling out a SaaS-based version of that. I recognize it's early in that evolution, but knowing you just came from bbcon and had some conversations with customers and the like, can you provide what you're hearing from customers with their desire to shift to a SaaS-based model?
And how we ought to think about sort of the timing and initial phases of that rollout?
Anthony W. Boor
Yes, it's an interesting comment and I talked to several of our customers at bbcon. I would say that there's a large portion of our existing customer base that are on Prem RE today that would be happy to stay on Prem with RE.
They're looking for us to make continued investments and improvements in feature and functionality for that product. I did not hear a lot of those existing on Prem customers asking for us to shift that offer to a true SaaS-based multi-tenant hosted solution on their behalf.
I do think that the subscription SaaS-based offer being bluebird [ph], as that matures over time, will be a very compelling solution for those folks to move to, but I don't think that they're asking for it. I do think that the SaaS-based subscription offer of a solution like bluebird [ph] reduces the cost and barrier-to-entry for new customers, so I do think that like we saw with FE, it will be an opportunity for people to buy, or in this case, rent the product, the solution, and therefore, should increase unit sales and hopefully, our revenue growth as a result.
But again, Tom, I think -- I did not hear our existing customers asking that we move that direction in the near term.
Tom M. Roderick - Stifel, Nicolaus & Co., Inc., Research Division
Great. Maybe one last one for me.
Just thinking about your commentary about a moderate reduction in the non-GAAP EBIT margin next year. Where do you want to put those dollars?
Should we think about this being predominant? Obviously you're going to spend on the product side for Raiser's Edge with bluebird [ph], but how should we think about sort of the sales and marketing line?
Is this a function of just more marketing spend in general or is there room to meaningfully expand the sales force? Just any commentary around where you'd like to put those dollars would be great.
Anthony W. Boor
Yes, it will be very specific. So it's early on in the planning discussions, so I can't speak exactly to what our ultimate decisions will be, but I can tell you from a moderate reduction, I wouldn't expect this to go backwards more than a couple of hundred basis points from our kind of 2013 overperformance.
I wouldn't want to take too drastic of an investment kind of approach to things, but as far as where we'll invest, you'll see some incremental investment in some of the SaaS solutions. We'll continue to work on maturing the Online Express solution because that will help us rationalize some of our products in online space.
You'll see some continued investment in bluebird [ph]. Incremental investment, we made a commitment at bbcon.
We're going to make some incremental new investments on the Edge products to help keep those customers happy and on-board with that, those -- and also, try and keep retention rates high as they've been. I will expect on the sales and marketing front, there will be some incremental marketing spend, but more of the spend will be on direct sales efforts.
We currently believe we've got an opportunity to improve retention slightly with a bit more focus on customer success and retention efforts, largely within the GMBU area. We would also plan to expand sales -- direct sales teams within certain products, lines and verticals within the various business units.
And those decisions will be made upon more of a CAC [ph] ratio approach, where we're getting a very quick and adequate return on sales and marketing and think we've got an opportunity to expand sales and marketing to drive more growth and still get an adequate return. And we'll make sure we put in the right measurable, so that we can pull back on those reins very quickly if we see that we're not getting the right return on those investments.
Operator
Our next question is from the line of Matthew Kempler with Sidoti.
Matthew J. Kempler - Sidoti & Company, LLC
So just a follow-up to that question. Tony, is your belief that the company has been underinvested in their go-to-market strategy at this point in time, or is this more about capitalizing on new opportunities?
Anthony W. Boor
So Matt, I think that -- there's a couple of things that led to where we are. I do think we've been underinvested in certain areas, certain products and certain verticals.
Some of the analysis that we've done this year has given us better insight to that of where we think we got that elasticity and opportunity to drive more growth and I think that comes from us just becoming a bit smarter and a bit maturer as a company on how we look at that. I think secondarily, we've been running well behind where we had planned to be.
So part of our profitability overperformance in the year is certainly because we've been less successful than we had planned to be from a hiring front. And so we're still well behind on R&D investments, headcount investments and sales and marketing heads.
We're trying to make a concerted effort to ramp those headcount increases up and that's part of where you'll see some of the decline in the Q4 earnings guidance as we are anticipating that we'll make some headway on that front. But I think that there certainly was also an impact at the beginning of the year as we went through the Convio integration and rationalization and obtaining synergies where we may have through all of that integration work overcut in certain places as well.
So I think it's going to be a combination of all 3 of those things. While we were underinvesting in certain areas, we may have overcut in a couple of others and then we've just had a difficult time hiring as quickly as we would have liked to.
Matthew J. Kempler - Sidoti & Company, LLC
Okay. And then -- so it sounds like 2014, tied to the spending, we're looking at modest earnings growth.
Maybe you can share your perspective on 2, 3 years out, what you expect the spending to yield for Blackbaud? Maybe, what kind of long-term growth you can see for the business coming out of this?
Anthony W. Boor
So I would say for long-term, from a revenue line perspective, that we would not be making the investments we're making if we didn't believe we can get back into double-digit growth in the next few years. From a -- EBIT perspective, I feel very comfortable with the tremendous improvement that we made just in the last year post-Convio.
I think we're going to be at the midpoint, we're what, 330 basis points improvement in non-GAAP EBIT this year over last year. We still have significant opportunities, I would say, within the organization to continue to improve EBIT.
As our top line growth accelerates, that allows us to gain leverage and scale as we improve some more of the back office infrastructure and simplify and standardize and automate with the transition to a SaaS business. That will give us an opportunity to gain leverage from a profitability perspective.
So I think there's ample opportunity on the bottom line and I certainly believe that we can improve EBIT. It will be a balancing act, Matt, I think, as we've spoken about before of how much of that do we put on the bottom line and give back to shareholders versus how much of that do we reinvest to drive more accelerated long-term revenue growth.
And as we all know that if we can actually get that accelerated revenue growth, that will give a better return to our shareholders than a point of EBIT will. So we'll continue to balance that much like what we talked about for '14 and see how we perform and we will adjust accordingly if we cannot deliver that accelerated growth.
And I would expect you'd see a ramp-up in how quickly we would deliver improved profitability.
Matthew J. Kempler - Sidoti & Company, LLC
Okay. And then last question for me is, just going to the Online Express product, could you reveal a little more what product platform is this built on?
And what should it long-term help rationalize and replace?
Anthony W. Boor
So it is a much more robust, easy-to-use, easy to implement, true SaaS-based online solution. It's still fairly immature from the standpoint of being able to replace some of our legacy mature products.
But thus far -- and we've tested it with several existing legacy clients and they've been very positive on the solution. Several of them have actually moved to it already.
I think that what you'll see is it becomes a very, very good cross-sell opportunity for us for all those existing Edge clients that don't currently have an online solution -- and I would expect as it matures over the next couple of years, that it would allow us to rationalize -- I don't want to say a specific number, somewhere between 2 to 4 of our existing products would be my expectation, that we would be able to rationalize with this Online Express solution as it matures.
Operator
Our next question comes from the line of Sterling Auty of JPMorgan.
Saket Kalia - JP Morgan Chase & Co, Research Division
Tony, it's Saket here for Sterling. A few questions if I may.
So sales and marketing was down, I think, both in dollars and as a percent of revenue quarter-over-quarter. So can you just talk about maybe how sales commissions came in relative to your expectations?
And maybe if there were any other line items that drove efficiency there?
Anthony W. Boor
So Saket, I think it's probably less of a commission issue and more back to my earlier comment that we're just behind on hiring. I can tell you it's interesting, as many people are still out of work, it's a tough market in the software business.
And so we've really wrestled with that all year to find the right caliber of folks and we've been running -- I think we spoke about it last quarter, I think we're running behind by about 100 heads of where we had planned to be and where we would like to be. Not all of those in sales and marketing, but a good chunk of them are sales and marketing.
And so that quarter-over-quarter, really, I think, is more of an impact of us just not getting to where we intended to be from a headcount perspective. And then there would be obviously, some commission impact typically when you're hiring folks, they're going to demand [ph] a different type of comp plan in those initial months when they're getting trained and up to speed.
So you would have some slight impact there, but very little more so on the headcount. And then where we are today to be clear is not only do we want to get those -- what were already planned heads hired, but incremental heads for sales and marketing and R&D on top of that.
So we are planning on an incremental investment above and beyond those 100 heads that we've been running short on all year.
Saket Kalia - JP Morgan Chase & Co, Research Division
Got it. And then sorry to make you talk more, but can you just maybe repeat what you said around the reasoning for going to gross revenue accounting around merchant services and maybe how much it's impacting fourth quarter revenue guidance?
I know -- I caught the $20 million impact or benefit for 2014.
Anthony W. Boor
No, happy to. So the regulatory environment on the credit card and payments business has changed dramatically over the last couple of years, more so even in the last 12 months.
Our prior processor that we utilized, I won't mention who it is, decided to get out of that business for the nonprofit space, just because of the increase in regulatory scrutiny. And as a result, we switched providers.
Switching providers and with increased regulatory scrutiny that we're seeing in the market, we've had to add quite a bit of additional work that we are required to do on our on our end regarding know your customer, anti-money laundering screening, fraud screening, OFAC screening, taking on more liability than what we have with our previous processor. And as a result, that skewed the accounting treatment from net to gross.
We would expect -- and our guidance includes in Q4 a $5 million increase in revenue and a $5 million increase in cost of goods. The net dollars on gross margin and net dollars in profit are 0, right, so there's no change in profit dollars or gross margin dollars, but you would see that increase in both revenue and cost of goods sold.
And we're estimating that to be about a $5 million impact in Q4 and then incremental $20 million on the year for 2014.
Saket Kalia - JP Morgan Chase & Co, Research Division
Got it. And that was something that you decided to do starting in Q4, correct?
Anthony W. Boor
Yes, we just signed -- recently signed that contract with the new processor and recently transitioned our customer base to that new processor. And that with the change in the regulatory environment over the last few quarters is what drove that change in accounting.
We made that as part of our Q3 close but had no impact in Q3. It will be a prospective change for Q4 forward.
Saket Kalia - JP Morgan Chase & Co, Research Division
Got it. And then just kind of lastly on cash flow, do you expect -- I think the fourth quarter has sort of been your seasonally strongest cash flow quarter, so just wondering if you expect that to continue to be the case.
And then as you sort of look at cash flow on an annual basis for this year, were there any onetime items besides Convio that maybe helped or hurt your cash flow? I guess I'm just trying to get an understanding for sort of what the naturally recurring level of cash flow is for the business?
Anthony W. Boor
Right. So we're not giving any specific guidance as to cash flow at this point for Q4.
I would tell you that I'm not aware of any anomalies. And so I think you can look at our historical trends.
I would tell you there's certainly a focus internally to continue to make improvements in our accounts receivable and related collection efforts. And I think if you look over the past few quarters, you'll see that DSO has trended positively as a result of those efforts.
From a cash flow perspective, we probably had a bit more in write-offs this year, just as part of the effort to clean up account receivable and get that in order. We put in new policy, new process, hired more collectors, taken a more aggressive approach.
So I think you'll continue to see some ongoing improvements from a balance sheet management perspective. One-time items, not a significant amount.
I think CapEx is relatively in line with where we expected for the year. Taxes are ramping up a bit because we're burning through some of the NOLs, so you'll, going forward, I tell you, you'll need to contemplate the impact of taxes -- cash taxes.
We did have a positive impact this year in the first quarter because of the R&D credit that will impact the tax -- cash tax rate. As you recall, the federal government had not extended that and they finally extended it in I think it was January of this year.
So we get that R&D tax credit. And then the probably only other kind of one-off cash items we'd have outside of Convio would have been related to like Marc's severance that would have been a onetime.
But again, in materiality to the total, not that large of a number.
Operator
Your next question comes from the line of Ross MacMillan with Jefferies.
Ross MacMillan - Jefferies LLC, Research Division
Tony, can you just -- your gross margins are, I think, back up to levels we haven't seen since 2010. And if we strip out the impact that we will see obviously from the gross versus net accounting on merchant services, what's your thought process around gross margins as we go into next year?
Should we see further expansion due to some of the leverage you're getting on subscription revenues and also on services improvement?
Anthony W. Boor
Yes, Ross, you hit it right on the head. So that continued shift to subscription should have a positive impact.
Convio had good strong gross margins and so that's having a positive impact, as well as just continued shift toward subscription. Joe and Kevin and their teams have done a very good job as well of making some improvements on the services side.
That's a little muted because of the impact of Convio. If you recall, Convio's services margin were roughly breakeven and so we've kind of had to work through that hurdle.
But we had a good quarter from a services margin perspective with Q3 and Joe and his professional service team and Kevin and his, continue to make good progress there. So I'd expect to see some continuing improvement in services gross margin.
And then I think the other big factor, Ross, will be is, how does that services revenue line trend? As you can see, it's flattened a bit.
As we've been working especially on the big CRM at the enterprise space level, we've really been working, as we said, to be able to bring those products downmarket to make them easier to implement, to improve the translation and conversion process, to reduce hours, less customization, more configuration, all of those related things we're doing are making some investments. Joe and team are on some new BI data warehouse query reporting tool that should help with those implementations and also create a new revenue offering for us.
And so I think that one of the other key pieces will be how that services revenue plays out as a percentage of the total mix. So we should have subscriptions continuing to grow, services margins continuing to improve and then the real wild card's going to be how much of a drag on revenue is services because we actually would like to see that not grow as quickly, right?
We'd like to see services come down as far as a ratio of services to software or services to total contract price. So we'll just have to see how that plays out over time, but that would also have a positive impact on gross margins.
Ross MacMillan - Jefferies LLC, Research Division
That's helpful. And -- so the just the way we should think about this, going back to the gross to net on the merchant services, it's really $5 million in Q4, $20 million next year, so it's sort of net $15 million next year and there's an equivalent offset in COGS?
So basically, the impact to margins is all going to come from below the line, i.e. in OpEx, is that right?
Anthony W. Boor
Correct. I'm trying to see -- I think we did a rough calculation on that.
Hold on. Give me just 1 sec, Ross.
So our rough estimate was, it was going to have about a 70-basis-point impact on gross margins.
Ross MacMillan - Jefferies LLC, Research Division
Okay. That's helpful.
And then just 2 questions. Just on subscription revenue, there's obviously some lumpiness in there with the transactional piece.
Can you just maybe help us understand what you think that is currently sort of growing at from a recurring standpoint? If you could sort of look past the transactional elements of subscription that are going to be a little bit noisy quarter-to-quarter, what sort of underlying growth are you seeing in the kind of recurring component?
Anthony W. Boor
I can't give you the specific, because we don't give that level of granularity at this point in time. I can tell you that the usage or transactional component of that subscription piece is about 20% of the total subscription.
We've got training in there, we got the payments business and related usage type component. The payments business has been a very good growth opportunity for us, so we continue to see that growing rather -- at a rather high growth rate comparatively to the rest of the business, continuing into '14 and beyond.
That will mute a bit on the margin line as we said now that, that moves to gross, but that is certainly growing faster. And so I would expect we would see, as you look out into the future, a continued potential shift in the amount of usage or transaction as a percentage of the total, at least for the next couple of years, just because of the growth rate in that transaction side is faster than recurring subscription.
Ross MacMillan - Jefferies LLC, Research Division
That's helpful. And maybe just one last one.
Europe was particularly strong, I think, this quarter. You called out some deals there.
Is there something -- we're all mindful of Europe improving from a macroeconomic standpoint. Is there something above and beyond macro improvement that you think is starting to help you drive more growth out of Europe?
Anthony W. Boor
Europe was strong from a CRM perspective. I would not say that it was strong or exceeded our expectations from an overall holistic perspective.
So there's still a lot of uncertainty, I think, around the world, inclusive of Europe. Our legacy products did not do as -- anything over, above and beyond what we would have expected.
And I think the key here is that we see more opportunities with CRM on more global type and international organizations. So I think it's more so the growth in that specific set of offers, being LCRM or BBCRM to those larger enterprise-type customers on the international front is where you're seeing that incremental growth.
Still a lot, I think, to be desired yet for the economy to turn around and see the growth ramp back up on the other legacy products. That said, we are making some incremental investments in Everyday Hero to roll that out to the rest of the world, and so we would certainly hope to see some incremental growth from that Everyday Hero product in 2014, certainly and going forward.
And then we hope to bring that solution as well to the U.S. sometime late next year as well.
And so we would hope to see some growth from some of those solutions elsewhere.
Operator
At this time, we've reached the end of our allotted question-and-answer session for today. I will turn the floor back to management for closing comments.
Anthony W. Boor
Well, thank you, all, for us today. I appreciate that.
We had, again, a very good third quarter. I'm very happy with where we are.
I'm enjoying this Interim CEO role. We did not get a question on that one, maybe I'll just give everybody a quick update.
I'm sure everybody is wondering how it's going. The search is going very well.
We've had very good interest. The board is happy with the caliber and number of qualified candidates that we see, and I think the good news is that the management team that's in place is doing a great job as you can see from the results that we delivered in Q3 and will continue to execute until such time as we have new permanent CEO on board.
And I look forward to updating everybody on our guidance for 2014 on our next call after we get Q4 closed and talk to you then. Thank you.
Operator
This concludes today's teleconference. You may disconnect your lines at this time.
Thank you for your participation.