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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2020
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                     to                     .
Commission file number: 000-50600
 
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Blackbaud, Inc.
(Exact name of registrant as specified in its charter)
 
 
Delaware
11-2617163
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
65 Fairchild Street
Charleston, South Carolina 29492
(Address of principal executive offices, including zip code)
(843) 216-6200
(Registrant’s telephone number, including area code)
 
 
 
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol(s)
Name of Each Exchange on which Registered
Common Stock, $0.001 Par Value
BLKB
Nasdaq Global Select Market
 
 
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    
Yes     No  
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes     No  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
Accelerated filer   
Non-accelerated filer
 
Smaller reporting company
 
 
 
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    
Yes   No      
The number of shares of the registrant’s Common Stock outstanding as of April 29, 2020 was 49,621,157.








TABLE OF CONTENTS


First Quarter 2020 Form 10-Q
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1


Blackbaud, Inc.

 
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, including the documents incorporated herein by reference, contains forward-looking statements that anticipate results based on our estimates, assumptions and plans that are subject to uncertainty. These "forward-looking statements" are made subject to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements consist of, among other things, specific and overall impacts of the COVID-19 global pandemic on our financial condition and results of operations and on the markets and communities in which we and our customers and partners operate, trend analyses, statements regarding future events, future financial performance, our anticipated growth, the effect of general economic and market conditions, our business strategy and our plan to build and grow our business, our operating results, our ability to successfully integrate acquired businesses and technologies, the effect of foreign currency exchange rate and interest rate fluctuations on our financial results, the impact of expensing stock-based compensation, the sufficiency of our capital resources, our ability to meet our ongoing debt and obligations as they become due, and potential litigation involving us, all of which are based on current expectations, estimates, and forecasts, and the beliefs and assumptions of our management. Words such as “believes,” “seeks,” “expects,” “may,” “might,” “should,” “intends,” “could,” “would,” “likely,” “will,” “targets,” “plans,” “anticipates,” “aims,” “projects,” “estimates” or any variations of such words and similar expressions are also intended to identify such forward-looking statements. These forward-looking statements are subject to risks, uncertainties and assumptions that are difficult to predict. Accordingly, they should not be viewed as assurances of future performance, and actual results may differ materially and adversely from those expressed in any forward-looking statements.
Important factors that could cause actual results to differ materially from our expectations expressed in forward-looking statements include, but are not limited to, those summarized under “Part II, Item 1A. Risk factors” and elsewhere in this report, in our Annual Report on Form 10-K for the year ended December 31, 2019 and in our other SEC filings. Forward-looking statements represent our management's beliefs and assumptions only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to update or revise any forward-looking statements, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statement, whether as a result of new information, future events or otherwise.

2
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First Quarter 2020 Form 10-Q



 
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Blackbaud, Inc.
Consolidated Balance Sheets
(Unaudited)
(dollars in thousands)
March 31,
2020

December 31,
2019

Assets
 
 
Current assets:
 
 
Cash and cash equivalents
$
24,972

$
31,810

Restricted cash due to customers
232,250

545,485

Accounts receivable, net of allowance of $5,928 and $5,529 at March 31, 2020 and December 31, 2019, respectively
89,191

88,868

Customer funds receivable
1,205

524

Prepaid expenses and other current assets
81,004

67,852

Total current assets
428,622

734,539

Property and equipment, net
35,661

35,546

Operating lease right-of-use assets
100,568

104,400

Software development costs, net
105,594

101,302

Goodwill
631,033

634,088

Intangible assets, net
303,097

317,895

Other assets
66,346

65,193

Total assets
$
1,670,921

$
1,992,963

Liabilities and stockholders’ equity
 
 
Current liabilities:
 
 
Trade accounts payable
$
44,510

$
47,676

Accrued expenses and other current liabilities
45,781

73,317

Due to customers
233,455

546,009

Debt, current portion
10,351

7,500

Deferred revenue, current portion
288,682

314,335

Total current liabilities
622,779

988,837

Debt, net of current portion
520,576

459,600

Deferred tax liability
43,286

44,594

Deferred revenue, net of current portion
1,715

1,802

Operating lease liabilities, net of current portion
91,235

95,624

Other liabilities
10,937

5,742

Total liabilities
1,290,528

1,596,199

Commitments and contingencies (see Note 9)


Stockholders’ equity:
 
 
Preferred stock; 20,000,000 shares authorized, none outstanding


Common stock, $0.001 par value; 180,000,000 shares authorized, 60,932,639 and 60,206,091 shares issued at March 31, 2020 and December 31, 2019, respectively
61

60

Additional paid-in capital
471,344

457,804

Treasury stock, at cost; 11,311,712 and 11,066,354 shares at March 31, 2020 and December 31, 2019, respectively
(310,447
)
(290,665
)
Accumulated other comprehensive loss
(14,140
)
(5,290
)
Retained earnings
233,575

234,855

Total stockholders’ equity
380,393

396,764

Total liabilities and stockholders’ equity
$
1,670,921

$
1,992,963

 
 
 
The accompanying notes are an integral part of these consolidated financial statements.

First Quarter 2020 Form 10-Q
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3




Blackbaud, Inc.
Consolidated Statements of Comprehensive Income
(Unaudited)
(dollars in thousands, except per share amounts)
Three months ended 
 March 31,
 
2020

2019

Revenue
 
 
Recurring
$
204,867

$
198,094

One-time services and other
18,754

17,736

Total revenue
223,621

215,830

Cost of revenue
 
 
Cost of recurring
89,551

84,711

Cost of one-time services and other
15,314

14,572

Total cost of revenue
104,865

99,283

Gross profit
118,756

116,547

Operating expenses
 
 
Sales, marketing and customer success
58,735

55,455

Research and development
24,977

28,461

General and administrative
25,855

27,117

Amortization
741

1,376

Restructuring
24

1,953

Total operating expenses
110,332

114,362

Income from operations
8,424

2,185

Interest expense
(4,159
)
(5,323
)
Other income, net
1,070

182

Income (loss) before provision for income taxes
5,335

(2,956
)
Income tax provision (benefit)
696

(1,834
)
Net income (loss)
$
4,639

$
(1,122
)
Earnings (loss) per share
 
 
Basic
$
0.10

$
(0.02
)
Diluted
$
0.10

$
(0.02
)
Common shares and equivalents outstanding
 
 
Basic weighted average shares
48,036,300

47,516,912

Diluted weighted average shares
48,455,751

47,516,912

Other comprehensive (loss) income
 
 
Foreign currency translation adjustment
(5,728
)
4,590

Unrealized loss on derivative instruments, net of tax
(3,122
)
(932
)
Total other comprehensive (loss) income
(8,850
)
3,658

Comprehensive (loss) income
$
(4,211
)
$
2,536

 
 
 
The accompanying notes are an integral part of these consolidated financial statements.

4
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First Quarter 2020 Form 10-Q


Blackbaud, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
 
Three months ended 
 March 31,
 
(dollars in thousands)
2020

2019

Cash flows from operating activities
 
 
Net income (loss)
$
4,639

$
(1,122
)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
 
 
Depreciation and amortization
21,804

21,724

Provision for credit losses and sales returns
2,488

2,032

Stock-based compensation expense
13,580

13,726

Deferred taxes
954

(1,155
)
Amortization of deferred financing costs and discount
188

188

Other non-cash adjustments
102

1,820

Changes in operating assets and liabilities, net of acquisition and disposal of businesses:
 
 
Accounts receivable
(3,876
)
(1,797
)
Prepaid expenses and other assets
(5,303
)
(12,107
)
Trade accounts payable
(4,021
)
(3,624
)
Accrued expenses and other liabilities
(31,694
)
(11,690
)
Deferred revenue
(23,364
)
(18,006
)
Net cash used in operating activities
(24,503
)
(10,011
)
Cash flows from investing activities
 
 
Purchase of property and equipment
(2,867
)
(1,152
)
Capitalized software development costs
(10,937
)
(11,319
)
Purchase of net assets of acquired companies, net of cash and restricted cash acquired

(109,386
)
Net cash used in investing activities
(13,804
)
(121,857
)
Cash flows from financing activities
 
 
Proceeds from issuance of debt
144,700

271,500

Payments on debt
(86,075
)
(75,175
)
Employee taxes paid for withheld shares upon equity award settlement
(19,782
)
(18,400
)
Proceeds from exercise of stock options
1

3

Change in due to customers
(311,095
)
(242,885
)
Change in customer funds receivable
(733
)
(3,573
)
Dividend payments to stockholders
(5,960
)
(5,901
)
Net cash used in financing activities
(278,944
)
(74,431
)
Effect of exchange rate on cash, cash equivalents and restricted cash
(2,822
)
1,036

Net decrease in cash, cash equivalents and restricted cash
(320,073
)
(205,263
)
Cash, cash equivalents and restricted cash, beginning of period
577,295

449,846

Cash, cash equivalents and restricted cash, end of period
$
257,222

$
244,583

The following table provides a reconciliation of cash and cash equivalents and restricted cash reported within the consolidated balance sheets that sum to the total of the same such amounts shown above in the consolidated statements of cash flows:
(dollars in thousands)
March 31,
2020

December 31,
2019

Cash and cash equivalents
$
24,972

$
31,810

Restricted cash due to customers
232,250

545,485

Total cash, cash equivalents and restricted cash in the statement of cash flows
$
257,222

$
577,295

 
 
 
The accompanying notes are an integral part of these consolidated financial statements.


First Quarter 2020 Form 10-Q
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5

Blackbaud, Inc.
Consolidated Statements of Stockholders' Equity
(Unaudited)


(dollars in thousands)
Common stock
 
Additional
paid-in
capital

Treasury
stock

Accumulated
other
comprehensive
income (loss)

Retained
earnings

Total stockholders' equity

Shares

Amount

Balance at December 31, 2019
60,206,091

$
60

$
457,804

$
(290,665
)
$
(5,290
)
$
234,855

$
396,764

Net income





4,639

4,639

Payment of dividends ($0.12 per share)





(5,960
)
(5,960
)
Exercise of stock options and vesting of restricted stock units
210,057


1




1

Employee taxes paid for 245,358 withheld shares upon equity award settlement



(19,782
)


(19,782
)
Stock-based compensation


13,539



41

13,580

Restricted stock grants
563,947

1





1

Restricted stock cancellations
(47,456
)






Other comprehensive loss




(8,850
)

(8,850
)
Balance at March 31, 2020
60,932,639

$
61

$
471,344

$
(310,447
)
$
(14,140
)
$
233,575

$
380,393

 
 
 
 
 
 
 
 
 
(dollars in thousands)
Common stock
 
Additional
paid-in
capital

Treasury
stock

Accumulated
other
comprehensive
income (loss)

Retained
earnings

Total stockholders' equity

Shares

Amount

Balance at December 31, 2018
59,327,633

$
59

$
399,241

$
(266,884
)
$
(5,110
)
$
246,477

$
373,783

Net loss





(1,122
)
(1,122
)
Payment of dividends ($0.12 per share)





(5,901
)
(5,901
)
Exercise of stock options and stock appreciation rights and vesting of restricted stock units
234,453


3




3

Employee taxes paid for 239,311 withheld shares upon equity award settlement



(18,400
)


(18,400
)
Stock-based compensation


13,693



33

13,726

Restricted stock grants
663,906

1





1

Restricted stock cancellations
(43,314
)






Other comprehensive income




3,658


3,658

Balance at March 31, 2019
60,182,678

$
60

$
412,937

$
(285,284
)
$
(1,452
)
$
239,487

$
365,748

 
 
 
 
 
 
 
 
The accompanying notes are an integral part of these consolidated financial statements.


6
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First Quarter 2020 Form 10-Q


Blackbaud, Inc.
Notes to Consolidated Financial Statements
(Unaudited)



1. Organization
We are the world’s leading cloud software company powering social good. Serving the entire social good community—nonprofits, higher education institutions, K–12 schools, healthcare organizations, faith communities, arts and cultural organizations, foundations, companies and individual change agents—we connect and empower organizations to increase their impact through cloud software, services, expertise and data intelligence. Our portfolio is tailored to the unique needs of vertical markets, with solutions for fundraising and CRM, marketing, advocacy, peer-to-peer fundraising, corporate social responsibility, school management, ticketing, grantmaking, financial management, payment processing and analytics. Serving the industry for more than three decades, we are headquartered in Charleston, South Carolina, and have operations in the United States, Australia, Canada, Costa Rica and the United Kingdom.
2. Basis of Presentation
Unaudited interim consolidated financial statements
The accompanying interim consolidated financial statements have been prepared pursuant to the rules and regulations of the United States Securities and Exchange Commission ("SEC") for interim financial reporting. These consolidated statements are unaudited and, in the opinion of management, include all adjustments (consisting of normal recurring adjustments and accruals) necessary to state fairly the consolidated balance sheets, consolidated statements of comprehensive income, consolidated statements of cash flows and consolidated statements of stockholders’ equity, for the periods presented in accordance with accounting principles generally accepted in the United States ("U.S.") ("GAAP"). The consolidated balance sheet at December 31, 2019 has been derived from the audited consolidated financial statements at that date. Operating results and cash flows for the three months ended March 31, 2020 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2020, or any other future period. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been omitted in accordance with the rules and regulations for interim reporting of the SEC. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2019, and other forms filed with the SEC from time to time.
Basis of consolidation
The consolidated financial statements include the accounts of Blackbaud, Inc. and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Reportable segment
We report our operating results and financial information in one operating and reportable segment. Our chief operating decision maker uses consolidated financial information to make operating decisions, assess financial performance and allocate resources. Our chief operating decision maker is our chief executive officer ("CEO").
Risks and uncertainties
Impacts of COVID-19
We are subject to risks and uncertainties as a result of the global COVID-19 pandemic. We expect that COVID-19 will impact all of our vertical markets, across all of our geographies to some degree, but the significance and duration of the impact on our business cannot be determined at this time due to numerous uncertainties, including the ultimate geographic spread of the disease, the duration of the outbreak, travel restrictions and business closures, the effectiveness of actions taken to contain the disease and other unforeseeable consequences.

First Quarter 2020 Form 10-Q
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7


Blackbaud, Inc.
Notes to Consolidated Financial Statements (Continued)
(Unaudited)


The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. On an ongoing basis, we reconsider and evaluate our estimates and assumptions, including those that impact revenue recognition, long-lived and intangible assets, income taxes, stock-based compensation, capitalization of software development costs, our allowances for credit losses and sales returns, costs of obtaining contracts, valuation of derivative instruments and loss contingencies, among others. Changes in the facts or circumstances underlying these estimates due to COVID-19 could result in material changes and actual results could materially differ from these estimates.
Recently adopted accounting pronouncements
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 requires certain types of financial instruments, including trade receivables, to be presented at the net amount expected to be collected based on historical events, current conditions and forward-looking information. We adopted ASU 2016-13 as of the January 1, 2020 effective date and the adoption did not have a material impact on our consolidated financial statements.
In August 2018, the FASB issued ASU 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”). ASU 2018-15 aligns the accounting for implementation costs related to a hosting arrangement that is a service contract with the guidance on capitalizing costs associated with developing or obtaining internal-use software. We adopted ASU 2018-15 prospectively as of the January 1, 2020 effective date and the adoption did not have a material impact on our consolidated financial statements.
Recently issued accounting pronouncements
There are no recently issued accounting pronouncements that are expected to have a material impact on our financial position or results of operations when adopted in the future.
Summary of significant accounting policies
Except for the accounting policies for allowance for credit losses and allowance for sales returns below that were updated as a result of adopting ASU 2016-13, there have been no new or material changes to our significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on February 20, 2020.
Allowance for credit losses
Our accounts receivable consist of a single portfolio segment. Accounts receivable are recorded at original invoice amounts less an allowance for credit losses, an amount we estimate to be sufficient to provide adequate protection against lifetime expected losses resulting from extending credit to our customers. In judging the adequacy of the allowance for credit losses, we consider multiple factors including historical bad debt experience, the current aging of our receivables and current economic conditions that may affect our customers' ability to pay. A considerable amount of judgment is required in assessing these factors and if any receivables were to deteriorate, an additional provision for credit losses could be required. Accounts are written off after all means of collection are exhausted and recovery is considered remote. Provisions for credit losses are recorded in general and administrative expense.
Below is a summary of the changes in our allowance for credit losses.
(in thousands)
Balance at
beginning of year (1)

Provision/
adjustment

Write-off

Recovery

Balance at March 31, 2020

2020
$
4,011

$
593

$
(466
)
$
172

$
4,310

(1)
Upon adoption of ASU 2016-13 at January 1, 2020, we reclassified certain balances previously disclosed within the allowance for sales returns to the allowance for credit losses, as these amounts reflect the credit risk associated with our accounts receivable.
The increase in our allowance for credit losses and the amount of write-offs during the three months ended March 31, 2020 were insignificant.

8
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First Quarter 2020 Form 10-Q


Blackbaud, Inc.
Notes to Consolidated Financial Statements (Continued)
(Unaudited)


Allowance for sales returns
We maintain a reserve for returns and credits which is estimated based on several factors including historical experience, known credits yet to be issued, the aging of customer accounts and the nature of service level commitments. A considerable amount of judgment is required in assessing these factors. Provisions for sales returns and credits are charged against the related revenue items.
Below is a summary of the changes in our allowance for sales returns.
(in thousands)
Balance at
beginning of year
(1)

Provision/
adjustment

Deduction

Balance at March 31, 2020

2020
$
1,518

$
1,895

$
(1,795
)
$
1,618

(1)
As discussed above, we reclassified certain balances previously disclosed within the allowance for sales returns to the allowance for credit losses upon adoption of ASU 2016-13 at January 1, 2020.
3. Goodwill and Other Intangible Assets
The change in goodwill during the three months ended March 31, 2020, consisted of the following:
(dollars in thousands)
Total
Balance at December 31, 2019
$
634,088

Effect of foreign currency translation
(3,055
)
Balance at March 31, 2020
$
631,033


4. Earnings (Loss) Per Share

We compute basic earnings (loss) per share by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is computed by dividing net income available to common stockholders by the weighted average number of common shares and dilutive potential common shares outstanding during the period. Diluted earnings (loss) per share reflect the assumed exercise, settlement and vesting of all dilutive securities using the “treasury stock method” except when the effect is anti-dilutive. Potentially dilutive securities consist of shares issuable upon the exercise of stock options, settlement of stock appreciation rights and vesting of restricted stock awards and units. Diluted loss per share for the three months ended March 31, 2019 was the same as basic loss per share as there was a net loss in the period and inclusion of potentially dilutive securities was anti-dilutive.

First Quarter 2020 Form 10-Q
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9


Blackbaud, Inc.
Notes to Consolidated Financial Statements (Continued)
(Unaudited)


The following table sets forth the computation of basic and diluted earnings (loss) per share:
  
Three months ended 
 March 31,
 
(dollars in thousands, except per share amounts)
2020

2019

Numerator:
 
 
Net income (loss)
$
4,639

$
(1,122
)
Denominator:
 
 
Weighted average common shares
48,036,300

47,516,912

Add effect of dilutive securities:
 
 
Stock-based awards
419,451


Weighted average common shares assuming dilution
48,455,751

47,516,912

Earnings (loss) per share:
 
 
Basic
$
0.10

$
(0.02
)
Diluted
$
0.10

$
(0.02
)
 
 
 
Anti-dilutive shares excluded from calculations of diluted earnings (loss) per share
1,170,289

740,119


5. Fair Value Measurements
We use a three-tier fair value hierarchy to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows:
Level 1 - Quoted prices for identical assets or liabilities in active markets;
Level 2 - Quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and
Level 3 - Valuations derived from valuation techniques in which one or more significant inputs are unobservable.
Recurring fair value measurements
Assets and liabilities that are measured at fair value on a recurring basis consisted of the following, as of the dates indicated below:
 
Fair value measurement using
 
 
(dollars in thousands)
Level 1

 
Level 2

 
Level 3

 
Total

Fair value as of March 31, 2020
 
 
 
 
 
 
 
Financial liabilities:
 
 
 
 
 
 
 
Derivative instruments
$

 
$
5,979

 
$

 
$
5,979

Total financial liabilities
$

 
$
5,979

 
$

 
$
5,979

 
 
 
 
 
 
 
 
Fair value as of December 31, 2019
 
 
 
 
 
 
 
Financial liabilities:
 
 
 
 
 
 
 
Derivative instruments
$

 
$
1,757

 
$

 
$
1,757

Total financial liabilities
$

 
$
1,757

 
$

 
$
1,757



10
https://cdn.kscope.io/a97484b7108bcc3263acb8e54b77c8ae-bblogo.jpg
First Quarter 2020 Form 10-Q


Blackbaud, Inc.
Notes to Consolidated Financial Statements (Continued)
(Unaudited)


Our derivative instruments within the scope of Accounting Standards Codification ("ASC") 815, Derivatives and Hedging, are required to be recorded at fair value. Our derivative instruments that are recorded at fair value include interest rate swaps.
The fair value of our interest rate swaps was based on model-driven valuations using LIBOR rates, which are observable at commonly quoted intervals. Accordingly, our interest rate swaps are classified within Level 2 of the fair value hierarchy. The Financial Conduct Authority in the U.K. has stated that it plans to phase out LIBOR by the end of calendar year 2021. We do not currently anticipate a significant impact to our financial position or results of operations as a result of this action as we expect that our financial contracts currently indexed to LIBOR will either expire or be modified before the phase out occurs.
We believe the carrying amounts of our cash and cash equivalents, restricted cash due to customers, accounts receivable, trade accounts payable, accrued expenses and other current liabilities and due to customers approximate their fair values at March 31, 2020 and December 31, 2019, due to the immediate or short-term maturity of these instruments.
We believe the carrying amount of our debt approximates its fair value at March 31, 2020 and December 31, 2019, as the debt bears interest rates that approximate market value. As LIBOR rates are observable at commonly quoted intervals, our debt is classified within Level 2 of the fair value hierarchy.
We did not transfer any assets or liabilities among the levels within the fair value hierarchy during the three months ended March 31, 2020. Additionally, we did not hold any Level 3 assets or liabilities during the three months ended March 31, 2020.
Non-recurring fair value measurements
Assets and liabilities that are measured at fair value on a non-recurring basis include intangible assets, goodwill and operating lease right-of-use ("ROU") assets, which are recognized at fair value during the period in which an acquisition is completed or at lease commencement, from updated estimates and assumptions during the measurement period, or when they are considered to be impaired. These non-recurring fair value measurements, primarily for long-lived assets, intangible assets acquired and operating lease ROU assets, are based on Level 3 unobservable inputs. In the event of an impairment, we determine the fair value of these assets other than goodwill using a discounted cash flow approach, which contains significant unobservable inputs and, therefore, is considered a Level 3 fair value measurement. The unobservable inputs in the analysis generally include future cash flow projections and a discount rate. For goodwill impairment testing, we estimate fair value using market-based methods including the use of market capitalization and consideration of a control premium.
There were no non-recurring fair value adjustments to our long-lived assets, intangible assets, operating lease ROU assets and goodwill during the three months ended March 31, 2020.

First Quarter 2020 Form 10-Q
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11


Blackbaud, Inc.
Notes to Consolidated Financial Statements (Continued)
(Unaudited)


6. Consolidated Financial Statement Details
Prepaid expenses and other assets
(dollars in thousands)
March 31,
2020

December 31,
2019

Costs of obtaining contracts(1)(2)
$
86,867

$
90,764

Prepaid software maintenance and subscriptions(3)
30,097

17,384

Implementation costs for cloud computing arrangements, net(4)(5)
8,881

7,294

Unbilled accounts receivable
8,145

6,233

Prepaid insurance
2,994

1,585

Taxes, prepaid and receivable
843

849

Security deposits
864

885

Other assets
8,659

8,051

Total prepaid expenses and other assets
147,350

133,045

Less: Long-term portion
66,346

65,193

Prepaid expenses and other current assets
$
81,004

$
67,852


(1)
Amortization expense from costs of obtaining contracts was $9.5 million and $9.6 million for the three months ended March 31, 2020 and 2019, respectively.
(2)
The current portion of costs of obtaining contracts as of March 31, 2020 and December 31, 2019 was $31.9 million and $33.0 million, respectively.
(3)
The current portion of prepaid software maintenance and subscriptions as of March 31, 2020 and December 31, 2019 was $24.7 million and $16.1 million, respectively.
(4)
These costs, which were previously included in prepaid software maintenance and subscriptions, primarily relate to the multi-year implementations of our new global enterprise resource planning and customer relationship management systems.
(5)
Amortization expense from capitalized cloud computing implementation costs was insignificant for the three months ended March 31, 2020 and 2019, respectively. Accumulated amortization for these costs was insignificant as of March 31, 2020 and December 31, 2019.

Accrued expenses and other liabilities
(dollars in thousands)
March 31,
2020

December 31,
2019

Operating lease liabilities, current portion
$
19,672

$
19,784

Accrued bonuses(1)
2,116

24,617

Accrued commissions and salaries
3,945

6,980

Taxes payable
4,659

6,835

Derivative instruments
5,979

1,757

Customer credit balances
4,359

4,505

Unrecognized tax benefit
3,821

3,758

Accrued vacation costs
2,145

2,232

Accrued health care costs
2,416

2,399

Other liabilities
7,606

6,192

Total accrued expenses and other liabilities
56,718

79,059

Less: Long-term portion
10,937

5,742

Accrued expenses and other current liabilities
$
45,781

$
73,317


(1)
In March 2020, we reduced our accrued bonuses due to the payment of bonuses from the prior year and, in response to the global COVID-19 pandemic, determined to replace our 2020 cash bonus plans with performance-based equity awards (See Note 15 to these financial statements).


12
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First Quarter 2020 Form 10-Q


Blackbaud, Inc.
Notes to Consolidated Financial Statements (Continued)
(Unaudited)


Other income, net
  
Three months ended 
 March 31,
 
(dollars in thousands)
2020

2019

Interest income
$
522

$
654

Other income (expense), net
548

(472
)
Other income, net
$
1,070

$
182


7. Debt
The following table summarizes our debt balances and the related weighted average effective interest rates, which includes the effect of interest rate swap agreements.
 
Debt balance at
 
 
Weighted average
effective interest rate at
 
(dollars in thousands)
March 31,
2020

December 31,
2019

 
March 31,
2020

December 31,
2019

Credit facility:
 
 
 
 
 
    Revolving credit loans
$
247,500

$
187,000

 
2.51
%
3.11
%
    Term loans
279,375

281,250

 
2.99
%
3.22
%
Other debt
5,083


 
5.00
%
%
        Total debt
531,958

468,250

 
2.79
%
3.18
%
Less: Unamortized discount and debt issuance costs
1,031

1,150

 
 
 
Less: Debt, current portion
10,351

7,500

 
3.00
%
3.05
%
Debt, net of current portion
$
520,576

$
459,600

 
2.78
%
3.18
%

2017 credit facility
In June 2017, we entered into a five-year $700.0 million senior credit facility (the "2017 Credit Facility"). At March 31, 2020, we were in compliance with our debt covenants under the 2017 Credit Facility.
Other debt
In December 2019, we entered into a 51-month $2.2 million agreement to finance our purchase of software and related services for our internal use. The agreement is a non-interest-bearing note requiring four equal annual payments, where the first payment was due in January 2020. Interest associated with the note will be imputed at the rate we would incur for amounts borrowed under the 2017 Credit Facility.
In January 2020, we entered into an additional 39-month $3.5 million agreement to finance our purchase of software and related services for our internal use. The agreement is a non-interest-bearing note requiring three equal annual payments, where the first payment was due in March 2020. Interest associated with the note will be imputed at the rate we would incur for amounts borrowed under the 2017 Credit Facility.

First Quarter 2020 Form 10-Q
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13


Blackbaud, Inc.
Notes to Consolidated Financial Statements (Continued)
(Unaudited)


As of March 31, 2020, the required annual maturities related to the 2017 Credit Facility and other debt were as follows:
Years ending December 31,
(dollars in thousands)
Annual maturities

2020 - remaining
$
6,782

2021 
9,194

2022 
515,444

2023 
538

2024 

Thereafter

Total required maturities
$
531,958


8. Derivative Instruments
Cash flow hedges
We generally use derivative instruments to manage our variable interest rate risk. We have entered into interest rate swap agreements, which effectively convert portions of our variable rate debt under the 2017 Credit Facility to a fixed rate for the term of the swap agreements. We designated each of the interest rate swap agreements as a cash flow hedge at the inception of the contracts.
The terms and notional values of our derivative instruments were as follows as of March 31, 2020:
(dollars in thousands)
Term of derivative instrument
Notional Value

Derivative instruments designated as hedging instruments:
 
 
Interest rate swap
July 2017 - July 2021
$
150,000

Interest rate swap
February 2018 - June 2021
50,000

Interest rate swap
June 2019 - June 2021
75,000

 
 
$
275,000


The fair values of our derivative instruments were as follows as of:
 
 
Liability Derivatives
(dollars in thousands)
Balance sheet location
March 31,
2020

December 31,
2019

Derivative instruments designated as hedging instruments:
 
 
 
Interest rate swaps, long-term portion
Other liabilities
$
5,979

$
1,757

Total derivative instruments designated as hedging instruments
 
$
5,979

$
1,757


The effects of derivative instruments in cash flow hedging relationships were as follows:
 
Gain (loss) recognized
in accumulated other
comprehensive
loss as of

Location
of gain (loss)
reclassified from
accumulated other
comprehensive
loss into income
Gain (loss) reclassified from accumulated
 other comprehensive loss into income

(dollars in thousands)
March 31,
2020

Three months ended 
 March 31, 2020

Interest rate swaps
$
(5,979
)
Interest expense
$
(205
)
 
 
 
 
 
March 31,
2019

 
Three months ended 
 March 31, 2019

Interest rate swaps
$
806

Interest expense
$
229



14
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First Quarter 2020 Form 10-Q


Blackbaud, Inc.
Notes to Consolidated Financial Statements (Continued)
(Unaudited)


Our policy requires that derivatives used for hedging purposes be designated and effective as a hedge of the identified risk exposure at the inception of the contract. Accumulated other comprehensive income (loss) includes unrealized gains or losses from the change in fair value measurement of our derivative instruments each reporting period and the related income tax expense or benefit. Changes in the fair value measurements of the derivative instruments and the related income tax expense or benefit are reflected as adjustments to accumulated other comprehensive income (loss) until the actual hedged expense is incurred or until the hedge is terminated at which point the unrealized gain (loss) is reclassified from accumulated other comprehensive income (loss) to current earnings. The estimated accumulated other comprehensive loss as of March 31, 2020 that is expected to be reclassified into earnings within the next twelve months is $4.6 million. There were no ineffective portions of our interest rate swap derivatives during the three months ended March 31, 2020 and 2019. See Note 12 to these consolidated financial statements for a summary of the changes in accumulated other comprehensive income (loss) by component.
9. Commitments and Contingencies
Leases
We have operating leases for corporate offices, subleased offices and certain equipment and furniture. As of March 31, 2020, we had operating leases for equipment that had not yet commenced with future rent payments of $2.9 million. These operating leases are expected to commence during 2020 with lease terms of 3 to 5 years.
The components of lease expense were as follows:
 
Three months ended 
 March 31,
 
(dollars in thousands)
2020

2019

Operating lease cost(1)
$
6,311

$
6,001

Variable lease cost
1,258

991

Sublease income
(913
)
(705
)
Net lease cost
$
6,656

$
6,287

(1)
Includes short-term lease costs, which were immaterial.
Other commitments
The term loans under the 2017 Credit Facility require periodic principal payments. The balance of the term loans and any amounts drawn on the revolving credit loans are due upon maturity of the 2017 Credit Facility in June 2022.
We have contractual obligations for third-party technology used in our solutions and for other services we purchase as part of our normal operations. In certain cases, these arrangements require a minimum annual purchase commitment by us. As of March 31, 2020, the remaining aggregate minimum purchase commitment under these arrangements was approximately $76.7 million through 2023.
Solution and service indemnifications
In the ordinary course of business, we provide certain indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of our solutions or services. If we determine that it is probable that a loss has been incurred related to solution or service indemnifications, any such loss that could be reasonably estimated would be recognized. We have not identified any losses and, accordingly, we have not recorded a liability related to these indemnifications.
Legal proceedings
We are subject to legal proceedings and claims that arise in the ordinary course of business. We make a provision for a loss contingency when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. Unless otherwise specifically

First Quarter 2020 Form 10-Q
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15


Blackbaud, Inc.
Notes to Consolidated Financial Statements (Continued)
(Unaudited)


disclosed in this note, we have determined as of March 31, 2020, that no provision for liability nor disclosure is required related to any claim against us because (a) there is not a reasonable possibility that a loss exceeding amounts already recognized (if any) may be incurred with respect to such claim; (b) a reasonably possible loss or range of loss cannot be estimated; or (c) such estimate is immaterial. All legal costs associated with litigation are expensed as incurred. Litigation is inherently unpredictable. However, we believe that we have valid defenses with respect to the legal matters pending against us. It is possible, nevertheless, that our consolidated financial position, results of operations or cash flows could be negatively affected in any particular period by an unfavorable resolution of one or more of such proceedings, claims or investigations.
10. Income Taxes
Our income tax provision (benefit) and effective income tax rates, including the effects of period-specific events, were:
  
Three months ended 
 March 31,
 
(dollars in thousands)
2020

2019

Income tax provision (benefit)
$
696

$
(1,834
)
Effective income tax rate
13.0
%
62.0
%

The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law on March 27, 2020. The CARES Act did not have a material impact on our provision for income taxes for the three months ended March 31, 2020.  We will continue to analyze and monitor potential impact throughout the year.
The decrease in our effective income tax rate during the three months ended March 31, 2020, when compared to the same period in 2019, was primarily due to the impact of discrete tax benefits on pre-tax income for the quarter as compared to pre-tax loss for the same period in 2019.
11. Stock-based Compensation
Stock-based compensation expense is allocated to cost of revenue and operating expenses on the consolidated statements of comprehensive income based on where the associated employee’s compensation is recorded. The following table summarizes stock-based compensation expense:
  
Three months ended 
 March 31,
 
(dollars in thousands)
2020

2019

Included in cost of revenue:
 
 
Cost of recurring
$
470

$
512

Cost of one-time services and other
395

462

Total included in cost of revenue
865

974

Included in operating expenses:
 
 
Sales, marketing and customer success
2,478

2,911

Research and development
2,799

2,674

General and administrative
7,438

7,167

Total included in operating expenses
12,715

12,752

Total stock-based compensation expense
$
13,580

$
13,726



16
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First Quarter 2020 Form 10-Q


Blackbaud, Inc.
Notes to Consolidated Financial Statements (Continued)
(Unaudited)


12. Stockholders' Equity
Dividends
Our Board of Directors' previously adopted dividend policy provided for the distribution to stockholders of a portion of cash generated by us that was in excess of operational needs and capital expenditures. In February 2020, our Board of Directors approved an annual dividend rate of $0.48 per share to be made in quarterly payments, consistent with previous years.
In March 2020, in response to the global COVID-19 pandemic, our Board of Directors rescinded its previously announced policy to pay an annual dividend at a rate of $0.48 per share of common stock and discontinued the declaration and payment of all cash dividends, beginning with the second quarter of 2020 and thereafter until such time, if any, as it may otherwise determine in its sole discretion.
Dividends paid on common stock during the three months ended March 31, 2020, consisted of the following:
Declaration Date
Dividend
per Share

Record Date
 
Payable Date
February 10, 2020
$
0.12

February 28
 
March 13

Changes in accumulated other comprehensive income (loss) by component
The changes in accumulated other comprehensive income (loss) by component, consisted of the following:
 
Three months ended 
 March 31,
 
(dollars in thousands)
2020

2019

Accumulated other comprehensive loss, beginning of period
$
(5,290
)
$
(5,110
)
By component:
 
 
Gains and losses on cash flow hedges:
 
 
Accumulated other comprehensive (loss) income balance, beginning of period
$
(1,323
)
$
1,498

Other comprehensive loss before reclassifications, net of tax effects of $1,154 and $276
(3,273
)
(763
)
Amounts reclassified from accumulated other comprehensive loss to interest expense
205

(229
)
Tax (benefit) expense included in provision for income taxes
(54
)
60

Total amounts reclassified from accumulated other comprehensive loss
151

(169
)
Net current-period other comprehensive loss
(3,122
)
(932
)
Accumulated other comprehensive (loss) income balance, end of period
$
(4,445
)
$
566

Foreign currency translation adjustment:
 
 
Accumulated other comprehensive loss balance, beginning of period
$
(3,967
)
$
(6,608
)
Translation adjustments
(5,728
)
4,590

Accumulated other comprehensive loss balance, end of period
(9,695
)
(2,018
)
Accumulated other comprehensive loss, end of period
$
(14,140
)
$
(1,452
)

13. Revenue Recognition
Transaction price allocated to the remaining performance obligations
As of March 31, 2020, approximately $811 million of revenue is expected to be recognized from remaining performance obligations. We expect to recognize revenue on approximately 60% of these remaining performance obligations over the next 12 months, with the remainder recognized thereafter.

First Quarter 2020 Form 10-Q
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17


Blackbaud, Inc.
Notes to Consolidated Financial Statements (Continued)
(Unaudited)


We applied the practical expedient in ASC 606-10-50-14 and have excluded the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less (one-time services); and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed (payment services and usage).
Contract balances
Our contract assets as of March 31, 2020 and December 31, 2019 were insignificant. Our opening and closing balances of deferred revenue were as follows:
(in thousands)
March 31,
2020

December 31,
2019

Total deferred revenue
$
290,397

$
316,137


The decrease in deferred revenue during the three months ended March 31, 2020 was primarily due to less billings for recurring revenue contracts. Historically, due to the timing of customer budget cycles, we have an increase in customer contract renewals at or near the beginning of our third quarter generally resulting in our lowest balance of deferred revenue at the end of our first quarter. The amount of revenue recognized during the three months ended March 31, 2020 that was included in the deferred revenue balance at the beginning of the period was approximately $113 million. The amount of revenue recognized during the three months ended March 31, 2020 from performance obligations satisfied in prior periods was insignificant.
Disaggregation of revenue
We sell our cloud solutions and related services in two primary geographical markets: to customers in the United States, and to customers located outside of the United States. The following table presents our revenue by geographic area based on the address of our customers:
 
Three months ended 
 March 31,
 
(dollars in thousands)
2020

2019

United States
$
193,959

$
188,126

Other countries
29,662

27,704

Total revenue
$
223,621

$
215,830


The General Markets Group ("GMG"), the Enterprise Markets Group ("EMG"), and the International Markets Group ("IMG") comprise our go-to-market organizations. The following is a description of each market group:
The GMG focuses on sales primarily to all K-12 private schools, faith-based and arts and cultural organizations, as well as emerging and mid-sized prospects in the U.S.;
The EMG focuses on sales primarily to all healthcare and higher education institutions, corporations and foundations, as well as large and/or strategic prospects in the U.S.; and
The IMG focuses on sales primarily to all prospects and customers outside of the U.S.
The following table presents our revenue by market group:
 
Three months ended 
 March 31,
 
(dollars in thousands)
2020

2019

GMG
$
95,453

$
92,515

EMG
98,123

95,165

IMG
30,081

28,122

Other
(36
)
28

Total revenue
$
223,621

$
215,830



18
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First Quarter 2020 Form 10-Q


Blackbaud, Inc.
Notes to Consolidated Financial Statements (Continued)
(Unaudited)


14. Restructuring
During 2017, in an effort to further our organizational objectives, including improved operating efficiency, customer outcomes and employee satisfaction, we initiated a multi-year plan to consolidate and relocate some of our existing offices to highly modern and more collaborative workspaces with short-term financial commitments. We substantially completed our facilities optimization restructuring plan as of December 2019. We incurred $2.0 million in before-tax restructuring charges related to these activities during the three months ended March 31, 2019. Such charges during the three months ended March 31, 2020 were insignificant.
15. Subsequent Events

COVID-19
To better enable us to weather the extraordinary business challenges occasioned by the global COVID-19 pandemic, to protect the safety and welfare of our employees, and to further effect our long-term strategy to deliver the greatest value to our stockholders, we have taken several actions. These initial measures taken, in addition to suspending the payment of quarterly dividends as discussed in Note 12 to these consolidated financial statements, are expected to provide us the financial flexibility needed to manage a wide array of outcomes that may result from the pandemic. Certain of the actions commenced, after the quarter ended March 31, 2020, include the following:
Our 401(k) match program, whereby we have historically matched 50% of qualified U.S. employees' contributions to our 401(k) plan up to 6% of their salaries, was temporarily suspended effective with the payroll period commencing April 1, 2020. We have not yet determined when the match might recommence.
On May 1, 2020, we granted restricted stock units to our employees that were eligible for base salary merit increases in lieu of such increases, which will vest on May 1, 2021 subject to the recipient's continued employment with us. The grant date fair value of these awards was $8.3 million.
On May 1, 2020, we granted performance-based restricted stock units to our employees that were eligible for a 2020 cash bonus plan in lieu of such cash bonus, which may be earned and become eligible for vesting on May 1, 2021 subject to meeting certain performance conditions and the recipient's continued employment with us. The grant date fair value of these awards was $34.4 million.


First Quarter 2020 Form 10-Q
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19


Blackbaud, Inc.
(Unaudited)


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. The following discussion and analysis presents financial information denominated in millions of dollars which can lead to differences from rounding when compared to similar information contained in the consolidated financial statements and related notes which are primarily denominated in thousands of dollars.
Executive Summary
We are the world’s leading cloud software company powering social good. Serving the entire social good community—nonprofits, higher education institutions, K–12 schools, healthcare organizations, faith communities, arts and cultural organizations, foundations, companies and individual change agents—we connect and empower organizations to increase their impact through cloud software, services, expertise and data intelligence. Our portfolio is tailored to the unique needs of vertical markets, with solutions for fundraising and CRM, marketing, advocacy, peer-to-peer fundraising, corporate social responsibility, school management, ticketing, grantmaking, financial management, payment processing and analytics. Serving the industry for more than three decades, we are headquartered in Charleston, South Carolina, and have operations in the United States, Australia, Canada, Costa Rica and the United Kingdom.
Our revenue is primarily generated from the following sources: (i) charging for the use of our software solutions in cloud and hosted environments; (ii) providing payment and transaction services; (iii) providing software maintenance and support services; and (iv) providing professional services, including implementation, consulting, training, analytic and other services.
COVID-19 Impact
The outbreak of COVID-19 in numerous countries across the globe, including each country in which we currently operate, has adversely impacted the U.S. and global economies. We began 2020 with strong execution against our financial plan. In March 2020, we began to experience disruptions to our business from COVID-19, and the pandemic continues to impact each of our markets.
To better enable us to weather the extraordinary business challenges occasioned by the global COVID-19 pandemic, to protect the safety and welfare of our employees, and to further effect our long-term strategy to deliver the greatest value to our stockholders, we have taken several actions. These initial measures taken are expected to provide us the financial flexibility needed to manage a wide array of outcomes that may result from the pandemic and create over $300 million of additional annualized borrowing capacity. Some of these actions include the following:
Enacted our business continuity plans so that we can continue to serve our customers while protecting the well-being of our employees;
Closed our offices worldwide and transitioned our more than 3,600 global employees to work remotely;
Rescinded our previously announced policy to pay an annual dividend at a rate of $0.48 per share of common stock and discontinued the declaration and payment of all cash dividends, beginning with the second quarter of 2020 and thereafter until such time, if any, as our Board of Directors may otherwise determine in its sole discretion;
Temporarily suspended our 401(k) match program, whereby we have historically matched 50% of qualified U.S. employees' contributions to our 401(k) plan up to 6% of their salaries, effective with the payroll period commencing April 1, 2020;
Temporarily froze our hiring efforts;
Michael Gianoni, our President and Chief Executive Officer, elected to forego receipt of all but that portion of his base salary necessary to fund, on a pre-tax basis, his contributions to continue to participate in our health benefits plan, effective with the payroll period commencing April 1, 2020 and until Mr. Gianoni otherwise determines;
Restricted non-essential employee travel and put in place other operating cost reductions;
All of our employees with a base salary equal to or less than $75 thousand received financial support in the form of a one-time bonus of $1 thousand on April 30, 2020;

20
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First Quarter 2020 Form 10-Q


Blackbaud, Inc.
(Unaudited)


On May 1, 2020, we granted restricted stock units ("RSUs") to our employees that were eligible for base salary merit increases in lieu of such increases, which will vest on May 1, 2021 subject to the recipient's continued employment with us; and
On May 1, 2020, we granted performance-based restricted stock units ("PRSUs") to our employees that were eligible for a 2020 cash bonus plan in lieu of such cash bonus, which may be earned and become eligible for vesting on May 1, 2021 subject to meeting certain performance conditions and the recipient's continued employment with us.

In addition to the initial actions we have taken to date, we are continuously evaluating further possible actions in order to respond quickly to rapidly changing conditions, if needed. The economic impact of COVID-19 on the social good industry remains uncertain and, consequently, we expect that our operating environment may continue to be challenging for the remainder of 2020, and potentially beyond, as existing and prospective customers remain cautious in their purchase decisions.

Notwithstanding these conditions, we remain focused on continuing to execute our four-point growth strategy and strengthening our leadership position.
Four-Point Growth Strategy
 
1
 
Delight Customers with Innovative Cloud Solutions
 
 
 
 
 
 
 
2
 
Drive Sales Effectiveness
 
 
 
 
 
 
 
3
 
Expand Total Addressable Market
 
 
 
 
 
 
 
4
 
Improve Operating Efficiency
 
1.
Delight Customers with Innovative Cloud Solutions
Many of our customers have had to cancel or postpone their planned in-person fundraising events due to COVID-19 and our agile engineering teams have moved quickly to respond to these customers. We have been reprioritizing and expediting product enhancements to support their changing needs. Examples range from pivoting to virtual fitness events to putting new livestream fundraising tools in the hands of both organizations and individuals. This industry has been undergoing a digital transformation in which we have been the global leader and that has accelerated in recent weeks. Our move over the last several years to cloud solutions purpose-built for vertical markets has proved to be the right strategy as this crisis has highlighted how important modern, scalable, and secure cloud systems are now a required standard.
2.
Drive Sales Effectiveness
We have been investing in sales and marketing to better address our large market opportunity and, as part of this effort, we have implemented software tools to enhance our digital footprint and drive efficiency. The investments we have made enable us to quickly adapt to changing market conditions, including competitive opportunities. Our ability to ensure business continuity for our customers, perform at scale and pivot to offer solutions to the changing needs of our customers has become a new differentiator for us, and we have moved quickly to capitalize on these early opportunities by leveraging our enhanced go-to-market capabilities. While the disruption caused by the virus has caused some deal pipeline to push out to our second quarter and the second half of 2020, we have been able to showcase ourselves as the best long-term partner for social good organizations and we remain very well positioned as a leader in this market. As part of our cost control measures, we have put a freeze on hiring across the company, including sales.
3.
Expand TAM
While we remain active in the evaluation of opportunities to further expand our addressable market through acquisitions and internal product development, our top priority in the near-term is protecting our people and continuing to support our customers. We have significant opportunities in front of us as we are less than 10% penetrated into a total addressable market of over $10 billion.

First Quarter 2020 Form 10-Q
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21


Blackbaud, Inc.
(Unaudited)


4.
Improve Operating Efficiency
We have made transformational changes to our business, which has created a scalable operating model that has been tested with this global crisis. Our internal IT and organization structure changes over the last several years enabled us to immediately go virtual and have all of our global employees working from home as if they continued to come into the office every day, allowing our high level of support to continue. Our support teams immediately became an efficient mobile call center. Not only did the team maintain service levels, but they have driven customer satisfaction levels into the high nineties. Our implementation services teams had previously moved to a largely remote implementation model before this crisis and are fully equipped to continue customer engagements uninterrupted. We have reorganized our business to focus on vertical go-to-market teams with a centralized back-office consisting of global centers of excellence, and those changes are now benefiting us.
Financial Summary
Total revenue ($M)
 
Income from operations ($M)
YoY Growth (%)
 
YoY Growth (%)
       https://cdn.kscope.io/a97484b7108bcc3263acb8e54b77c8ae-chart-4134d1016058ca86370.jpg                           https://cdn.kscope.io/a97484b7108bcc3263acb8e54b77c8ae-chart-c56fae441fa91805b72.jpg
Total revenue increased by $7.8 million during the three months ended March 31, 2020, when compared to the same period in 2019, driven largely by the following:
 
+
 
Growth in recurring revenue related to an increase in payment services, positive demand from customers across our portfolio of cloud solutions and an increase in services embedded in our renewable cloud solution contracts
 
+
 
An increase in revenue from sales of retained and managed services
Income from operations increased by $6.2 million during the three months ended March 31, 2020, when compared to the same period in 2019, driven largely by the following:
 
+
 
Growth in total revenue, as described above
 
+
 
Decrease in employee severance of $3.3 million related to the elimination of certain roles within the company, most of which occurred during the first quarter of 2019
 
+
 
Decrease in restructuring costs of $1.9 million as our facilities optimization plan was largely completed as of December 31, 2019
 
+
 
Decrease in acquisition-related expenses and integration costs of $1.1 million
 
+
 
Decrease in amortization of intangible assets from business combinations of $1.1 million
 
-
 
Increase in cost of revenue of $5.6 million related to increases in transaction-based costs, amortization of software development costs, third-party contractor costs and data center costs
 
-
 
Increased investments we have made in our sales organization, including the elevated headcount of our direct sales force and our lead generation teams beginning in the fourth quarter of 2018


22
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First Quarter 2020 Form 10-Q


Blackbaud, Inc.
(Unaudited)


There are three primary revenue categories with related business drivers that we continue to monitor closely in light of the COVID-19 pandemic:
1.
Contractual Recurring Revenue (approximately two thirds of total revenue in 2019)
Recurring subscription contracts are typically for a term of three years at contract inception, billed annually in advance, and we have been for several years successfully shifting our legacy customer base away from annual renewals and moving them onto multi-year renewal contracts. Approximately one-half of our contracted recurring revenue will be up for renewal during 2020, with the seasonal high for renewals and collections during the third quarter driven largely by mid-year fiscal year-ends and timing of the academic school year. To date, our renewal rates are trending ahead of our pre-COVID-19 expectations. We are monitoring our customer receivable balances, payment terms, and creditworthiness and have not experienced a significant deterioration in our customers' ability to pay thus far.
2.
Transactional Revenue (approximately one quarter of total revenue in 2019)
Transactional revenue is non-contractual and less predictable given the susceptibility to certain drivers such as timing and number of events and marketing campaigns, as well as fluctuations in donation volumes and tuition payments. We have historically experienced seasonal highs during the fourth quarter due to year-end giving campaigns and during the second quarter when a large number of events are held. The early disruptions caused by COVID-19 drove sharp initial declines in our transactional volumes. In recent weeks, we have seen a rebound in volume in the form of online events and campaigns as our customers look for innovative ways to close funding gaps. We are focused on helping our customers successfully stand up virtual campaigns and events.
3.
Bookings
Given our ratable revenue recognition model for our recurring subscription contracts and implementation periods, we expect that any declines in our 2020 bookings performance will have a greater impact on our 2021 revenue than 2020. Of the three primary revenue categories discussed above, bookings represents the smallest potential impact on recurring revenue in 2020. One-time services and other revenue, which is tied to bookings, would have a more immediate impact on our total revenue. Our first quarter has historically been the seasonal low for bookings, with the second and fourth quarters historically being seasonally higher, and our bookings tend to be back-end loaded within individual quarters given our quarterly quota plans. Bookings fell off sharply in the second half of March 2020, and we have seen a slow-down in pipeline build. We are currently expecting a significant shortfall in 2020 bookings compared to our original plan for the year. The magnitude of our 2020 bookings shortfall is expected to be heavily impacted by the depth and duration of the COVID-19 pandemic. We have enabled our teams to offer relief measures to help ease the financial burden for our customers with near-term liquidity needs. For example, we have allowed, on a limited basis, for a 60-day extension on payment terms which will delay cash collections. However, we expect the impact to be largely offset during the third quarter. We have also partnered to offer zero-percent financing options for some customers on a case-by-case basis, and we continue to monitor and inform our customers on the available government assistance programs.
Customer retention
 
 
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First Quarter 2020 Form 10-Q
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23


Blackbaud, Inc.
(Unaudited)


Our recurring revenue contracts are generally for a term of three years at contract inception with one to three-year renewals thereafter. We anticipate a continued decrease in maintenance contract renewals as we transition our solution portfolio and maintenance customers from a perpetual license-based model to a cloud subscription delivery model. In the long term, we also anticipate an increase in recurring subscription contract renewals as we continue focusing on innovation, quality and the integration of our cloud solutions, which we believe will provide value-adding capabilities to better address our customers' needs. Due primarily to these factors, we believe a recurring revenue customer retention measure that combines recurring subscription, maintenance and service customer contracts provides a better representation of our customers' overall behavior. For the twelve months ended March 31, 2020, approximately 92% of our customers with recurring revenue contracts were retained. This customer retention rate is unchanged from our rate for the full year ended December 31, 2019.
Balance sheet and cash flow
At March 31, 2020, our cash and cash equivalents were $25.0 million and the carrying amount of our debt under the 2017 Credit Facility was $525.8 million. Our net leverage ratio was 2.61 to 1.00.
During the three months ended March 31, 2020, we used $24.5 million in cash for operations, had a net increase in our borrowings of $58.6 million, returned $6.0 million to stockholders by way of dividends and had aggregate cash outlays of $13.8 million for purchases of property and equipment and capitalized software development costs. Historically, due to lower revenues in our first quarter, combined with the payment of bonuses from the prior year in our first quarter and the payment of certain annual vendor contracts, our cash flow from operations has been lowest in our first quarter.


24
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First Quarter 2020 Form 10-Q


Blackbaud, Inc.
(Unaudited)


Results of Operations
Comparison of the three months ended March 31, 2020 and 2019
Revenue and Cost of Revenue
Recurring
 
 
 
 
Revenue ($M)
 
Cost of revenue ($M)
 
Gross profit ($M)
and gross margin (%)
YoY Growth (%)
 
YoY Growth (%)
 
 
https://cdn.kscope.io/a97484b7108bcc3263acb8e54b77c8ae-chart-55e6b436b44e14f5266.jpghttps://cdn.kscope.io/a97484b7108bcc3263acb8e54b77c8ae-chart-cdc4ae5e17070c8cd46.jpghttps://cdn.kscope.io/a97484b7108bcc3263acb8e54b77c8ae-chart-b257d86847a6f0d6eee.jpg
Recurring revenue is comprised of fees for the use of our subscription-based software solutions, which includes providing access to cloud solutions, hosting services, online training programs, subscription-based analytic services, such as donor acquisitions and data enrichment, and payment services. Recurring revenue also includes fees from maintenance services for our on-premises solutions, services included in our renewable subscription contracts, retained and managed services contracts that we expect to have a term consistent with our cloud solution contracts, and variable transaction revenue associated with the use of our solutions.
Cost of recurring revenue is primarily comprised of compensation costs for customer support and production IT personnel, hosting expenses, third-party contractor expenses, third-party royalty and data expenses, allocated depreciation, facilities and IT support costs, amortization of intangible assets from business combinations, amortization of software development costs, transaction-based costs related to payments services including remittances of amounts due to third-parties and other costs incurred in providing support and recurring services to our customers.
We continued to experience growth in sales of our cloud solutions as a percentage of total revenue as our customers continue to prefer cloud subscription offerings with integrated analytics, training and payment services. Recurring subscription contracts are typically for a term of three years at contract inception with one to three-year renewals thereafter. We intend to continue focusing on innovation, quality and integration of our cloud solutions, which we believe will drive future revenue growth.
Recurring revenue increased by $6.8 million, or 3.4%, during the three months ended March 31, 2020, when compared to the same period in 2019, driven primarily by the following:
 
+
 
Increase in subscriptions revenue of $10.6 million related to an increase in payment services, positive demand from customers across our portfolio of cloud solutions and an increase in services embedded in our renewable cloud solution contracts
 
-
 
Decrease in maintenance revenue of $3.9 million primarily related to our continuing efforts to migrate customers from legacy on-premises solutions onto our solutions powered by Blackbaud SKY, our modern cloud platform
Partially offsetting the increase in subscriptions revenue was a decrease in the mix of retained and managed services contracts we present in recurring. Revenue from retained and managed service contracts that we do not expect to have a term consistent with our cloud solution contracts is included in one-time services and other revenue beginning January

First Quarter 2020 Form 10-Q
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25


Blackbaud, Inc.
(Unaudited)


1, 2020. This change in presentation resulted in a $4.3 million decrease in recurring revenue and an offsetting increase to one-time services and other revenue during the three months ended March 31, 2020.
Cost of recurring revenue increased by $4.8 million, or 5.7%, during the three months ended March 31, 2020, when compared to the same period in 2019, driven primarily by the following:
 
+
 
Increase in transaction-based costs of $2.3 million, related to payment services integrated in our cloud solutions
 
+
 
Increase in amortization of software development costs of $1.4 million due to investments made on innovation, quality and the integration of our cloud solutions
 
+
 
Increase in third-party contractor costs of $1.2 million related to application security and partners delivering services embedded in our renewable cloud solution contracts
 
+
 
Increase in data center costs as we are migrating our cloud infrastructure to leading public cloud service providers
 
-
 
Decrease in costs associated with certain retained and managed services contracts for which revenue is included in one-time services and other revenue beginning January 1, 2020, as discussed above
The 0.9% decrease in recurring gross margin for the three months ended March 31, 2020, when compared to the same period in 2019, was primarily the result of incremental costs associated with our continued shift toward selling cloud solutions, including amortization of software development costs and data center costs. We expect continued pressure on recurring gross margin largely driven by duplicate data center costs as we migrate our cloud infrastructure to leading cloud service providers.
One-time services and other
 
 
 
 
Revenue ($M)
 
Cost of revenue ($M)
 
Gross profit ($M)
and gross margin (%)
YoY Growth (%)
 
YoY Growth (%)
 
 
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One-time services and other revenue is comprised of fees for one-time consulting, analytic and onsite training services, fees for retained and managed services contracts that we do not expect to have a term consistent with our cloud solution contracts, revenue from the sale of our software sold under perpetual license arrangements, fees from user conferences and third-party software referral fees.
Cost of one-time services and other is primarily comprised of compensation costs for professional services and onsite training personnel, other costs incurred in providing onsite customer training, third-party contractor expenses, data expense incurred to perform one-time analytic services, third-party software royalties, costs of user conferences, allocated depreciation, facilities and IT support costs and amortization of intangible assets from business combinations.

26
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First Quarter 2020 Form 10-Q


Blackbaud, Inc.
(Unaudited)


One-time services and other revenue increased by $1.0 million, or 5.7%, during the three months ended March 31, 2020, when compared to the same period in 2019, driven primarily by the following:
 
+
 
Increase in the mix of retained and managed services contracts we present in one-time services and other. Revenue from retained and managed service contracts that we do not expect to have a term consistent with our cloud solution contracts is included in one-time services and other revenue beginning January 1, 2020. This change in presentation resulted in a $4.3 million increase to one-time services and other revenue and an offsetting decrease in recurring revenue during the three months ended March 31, 2020.
 
-
 
Decrease in one-time consulting revenue of $1.7 million. Services are increasingly embedded in our renewable cloud solution contracts. Our embedded services are recorded as recurring revenue.
 
-
 
Decrease in one-time analytics revenue of $0.9 million as analytics are generally integrated in our cloud solutions
Cost of one-time services and other increased by $0.7 million, or 5.1%, during the three months ended March 31, 2020, when compared to the same period in 2019, driven primarily by the following:
 
+
 
Increase in costs of associated with certain retained and managed services contracts for which revenue is included in one-time services and other revenue beginning January 1, 2020, as discussed above
 
+
 
Increase in third-party contractor costs of $0.9 million, related to partners delivering services
 
-
 
Reduced amount of compensation costs primarily associated with the decision to replace our 2020 cash bonus plans with grants of performance-based equity awards
The 0.5% increase in one-time services and other gross margin during the three months ended March 31, 2020, when compared to the same period in 2019, was primarily the result of the decision to replace our 2020 cash bonus plans with grants of performance-based equity awards.
Operating Expenses
Sales, marketing and
customer success ($M)
 
Research and development ($M)
 
General and administrative ($M)
Percentages indicate expenses as a percentage of total revenue
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Sales, marketing and customer success
Sales, marketing and customer success expense includes compensation costs, variable sales commissions, travel-related expenses, advertising and marketing materials, public relations costs, variable reseller commissions and allocated depreciation, facilities and IT support costs.
We see a large market opportunity and continue to make investments to improve market coverage and drive sales effectiveness, which is a component of our four-point growth strategy. We have also implemented software tools to enhance our digital footprint and drive lead generation. Sales, marketing and customer success expenses increased by $3.3 million, or 5.9%, during the three months ended March 31, 2020, when compared to the same period in 2019. The increases in dollars and as a percentage of total revenue were primarily driven by an increase in compensation costs of $2.6 million primarily associated with the elevated headcount of our direct sales force and our lead generation teams, beginning in the fourth quarter of 2018. The increase in compensation costs related to elevated headcount was partially

First Quarter 2020 Form 10-Q
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27


Blackbaud, Inc.
(Unaudited)


offset by the decision in March 2020 to replace our 2020 cash bonus plans with grants of performance-based equity awards.
Research and development
Research and development expense includes compensation costs for engineering and product management personnel, third-party contractor expenses, software development tools and other expenses related to developing new solutions or upgrading and enhancing existing solutions that do not qualify for capitalization, and allocated depreciation, facilities and IT support costs.
We continue to make investments to delight our customers with innovative cloud solutions, which is a component of our four-point growth strategy. Research and development expenses decreased by $3.5 million, or 12.2%, during the three months ended March 31, 2020, when compared to the same period in 2019, primarily driven by the following: