UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2007

Or

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     .

BLACKBAUD, INC.

(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of		11-2617163
incorporation or organization)		(I.R.S. Employer Identification No.)

2000 Daniel Island Drive
Charleston, South Carolina 29492
(Address of principal executive offices, including zip code)

(843) 216-6200
(Registrant’s telephone number, including area code)

     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 þ  NO o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

     Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES o  NO þ

     The number of shares of the registrant’s Common Stock outstanding as of May 10, 2007 was 43,951,473.

 

 

BLACKBAUD, INC.

TABLE OF CONTENTS

		Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial statements
Consolidated balance sheets as of March 31, 2007 and December 31, 2006 (restated) (unaudited)			1
Consolidated statements of operations for the three months ended March 31, 2007 and 2006 (restated) (unaudited)			2
Consolidated statements of cash flows for the three months ended March 31, 2007 and 2006 (restated) (unaudited)			3
Consolidated statements of stockholders’ equity and comprehensive income for the three months ended March 31, 2007 and the year ended December 31, 2006 (restated) (unaudited)			4
Condensed notes to consolidated financial statements (unaudited)			5
Item 2. Management’s discussion and analysis of financial condition and results of operations			18
Item 3. Quantitative and qualitative disclosures about market risk			31
Item 4. Controls and procedures			32
PART II. OTHER INFORMATION
Item 2. Unregistered sales of equity securities and use of proceeds			33
Item 6. Exhibits			33
Signatures			34
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PART I- FINANCIAL INFORMATION

Item 1. Financial statements

Blackbaud, Inc.

						December 31,
		March 31,				2006
(in thousands, except share amounts)		2007				(Restated)
Assets
Current assets:
Cash and cash equivalents		$	15,982			$	67,783
Cash, restricted			—				518
Accounts receivable, net of allowance of $1,395 and $1,268 at March 31, 2007 and December 31, 2006, respectively			33,843				29,505
Prepaid expenses and other current assets			7,613				8,507
Deferred tax asset, current portion			5,820				5,318
Total current assets			63,258				111,631
Property and equipment, net			12,833				10,524
Deferred tax asset			60,538				62,302
Goodwill			40,527				2,518
Intangible assets, net			29,643				7,986
Other assets			34				48
Total assets		$	206,833			$	195,009
Liabilities and stockholders’ equity
Current liabilities:
Trade accounts payable		$	5,091			$	5,863
Accrued expenses and other current liabilities			16,631				16,047
Deferred acquisition costs, current portion			25				518
Capital lease obligations, current portion			488				—
Short-term debt			20,000				—
Deferred revenue			75,103				75,078
Total current liabilities			117,338				97,506
Deferred acquisition costs, long-term portion			—				271
Capital lease obligations, long-term portion			930				—
Deferred revenue, long-term portion			2,102				1,874
Other liabilities, long-term			976				—
Total liabilities			121,346				99,651
Commitments and contingencies (Note 9)
Stockholders’ equity:
Preferred stock; 20,000,000 shares authorized, none outstanding			—				—
Common stock, $.001 par value; 180,000,000 shares authorized, 49,289,798 and 49,205,522 shares issued at March 31, 2007 and December 31, 2006, respectively			49				49
Additional paid-in capital			90,995				88,409
Treasury stock, at cost; 5,365,963 and 4,743,895 shares at March 31, 2007 and December 31, 2006, respectively			(83,734	)			(69,630	)
Accumulated other comprehensive income			160				232
Retained earnings			78,017				76,298
Total stockholders’ equity			85,487				95,358
Total liabilities and stockholders’ equity		$	206,833			$	195,009

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

Blackbaud, Inc.

Consolidated statements of operations
(Unaudited)

		Three months ended March 31,
		2007				2006
(in thousands, except share and per share amounts)						(Restated)
Revenue
License fees		$	8,067			$	7,221
Services			18,314				13,714
Maintenance			22,436				19,039
Subscriptions			4,793				2,288
Other revenue			1,535				1,290
Total revenue			55,145				43,552
Cost of revenue
Cost of license fees			476				670
Cost of services			12,116				8,111
Cost of maintenance			4,019				3,207
Cost of subscriptions			1,924				540
Cost of other revenue			1,360				1,090
Total cost of revenue			19,895				13,618
Gross profit			35,250				29,934
Operating expenses
Sales and marketing			12,917				9,284
Research and development			6,827				6,024
General and administrative			6,144				5,461
Amortization			84				129
Total operating expenses			25,972				20,898
Income from operations			9,278				9,036
Interest income			371				149
Interest expense			(367	)			(12	)
Other (expense), net			(69	)			(29	)
Income before provision for income taxes			9,213				9,144
Income tax provision			3,457				3,584
Net income		$	5,756			$	5,560
Earnings per share
Basic		$	0.13			$	0.13
Diluted		$	0.13			$	0.12
Common shares and equivalents outstanding
Basic weighted average shares			43,662,569				42,883,929
Diluted weighted average shares			44,833,093				44,600,235
Dividends per share		$	0.085			$	0.070

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

Blackbaud, Inc.

Consolidated statements of cash flows
(Unaudited)

		Three months ended March 31,
		2007				2006
(in thousands)						(Restated)
Cash flows from operating activities
Net income		$	5,756			$	5,560
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			1,648				846
Provision for doubtful accounts and sales returns			491				256
Stock-based compensation expense			1,712				1,974
Amortization of deferred financing fees			12				12
Deferred taxes			2,012				1,269
Changes in assets and liabilities, net of acquisition
Accounts receivable			351				411
Prepaid expenses and other assets			1,695				(929	)
Trade accounts payable			(1,387	)			(1,354	)
Accrued expenses and other current liabilities			(3,049	)			(3,151	)
Deferred revenue			(1,694	)			(1,634	)
Net cash provided by operating activities			7,547				3,260
Cash flows from investing activities
Purchase of property and equipment			(1,050	)			(264	)
Purchase of net assets of acquired companies			(59,216	)			(6,081	)
Net cash used in investing activities			(60,266	)			(6,345	)
Cash flows from financing activities
Proceeds from issuance of debt			30,000				—
Proceeds from exercise of stock options			428				3,266
Excess tax benefit on exercise of stock options			446				2,922
Payments on debt			(10,000	)			—
Payments on debt acquired			(1,922	)			—
Payments on capital lease obligations			(92	)			—
Purchase of treasury stock			(14,104	)			(6,254	)
Dividend payments to stockholders			(3,768	)			(3,034	)
Net cash provided by (used in) financing activities			988				(3,100	)
Effect of exchange rate on cash and cash equivalents			(70	)			(8	)
Net decrease in cash and cash equivalents			(51,801	)			(6,193	)
Cash and cash equivalents, beginning of period			67,783				22,683
Cash and cash equivalents, end of period		$	15,982			$	16,490

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

Blackbaud, Inc.

																											Accumulated
															Additional												other								Total
		Comprehensive					Common stock								paid-in				Deferred				Treasury				comprehensive				Retained				stockholders’
(in thousands, except share amounts)		income					Shares				Amount				capital				compensation				stock				income				earnings				equity
Balance at December 31, 2005 (restated)								47,529,836			$	48			$	73,583			$	(6,497	)		$	(60,902	)		$	92			$	58,428			$	64,752
Net income (restated)		$	30,153					—				—				—				—				—				—				30,153				30,153
Payment of dividends			—					—				—				—				—				—				—				(12,283	)			(12,283	)
Purchase of 442,000 treasury shares under stock repurchase program and surrender of 34,562 shares upon option exercises and stock vesting			—					—				—				—				—				(8,728	)			—				—				(8,728	)
Exercise of stock options			—					1,449,468				1				7,863				—				—				—				—				7,864
Tax impact of exercise of nonqualified stock options			—					—				—				6,060				—				—				—				—				6,060
Reclassification due to adoption of new accounting pronouncement			—					—				—				(6,497	)			6,497				—				—				—				—
Cumulative effect adjustment to assume historical forfeitures			—					—				—				(20	)			—				—				—				—				(20	)
Stock-based compensation			—					—				—				7,420				—				—				—				—				7,420
Restricted stock grants			—					284,295				—				—				—				—				—				—				—
Restricted stock cancellations			—					(58,077	)			—				—				—				—				—				—				—
Translation adjustment, net of tax			140					—				—				—				—				—				140				—				140
Comprehensive income (restated)		$	30,293
Balance at December 31, 2006 (restated)								49,205,522				49				88,409				—				(69,630	)			232				76,298				95,358
Net income		$	5,756					—				—				—				—				—				—				5,756				5,756
Payment of dividends			—					—				—				—				—				—				—				(3,768	)			(3,768	)
Purchase of 620,878 treasury shares under stock repurchase program and surrender of 1,190 shares upon restricted stock vesting			—					—				—				—				—				(14,104	)			—				—				(14,104	)
Exercise of stock options			—					84,636				—				428				—				—				—				—				428
Tax impact of exercise of nonqualified stock options			—					—				—				446				—				—				—				—				446
Cumulative effect of FIN 48 adoption			—					—				—				—				—				—				—				(269	)			(269	)
Stock-based compensation			—					—				—				1,712				—				—				—				—				1,712
Restricted stock grants			—					4,319				—				—				—				—				—				—				—
Restricted stock cancellations			—					(4,679	)			—				—				—				—				—				—				—
Translation adjustment, net of tax			(72	)				—				—				—				—				—				(72	)			—				(72	)
Comprehensive income		$	5,684
Balance at March 31, 2007								49,289,798			$	49			$	90,995			$	—			$	(83,734	)		$	160			$	78,017			$	85,487

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

Blackbaud, Inc.

1. Organization

Blackbaud, Inc. (the “Company”) is the leading global provider of software and related services designed specifically for nonprofit organizations and provides products and services that enable nonprofit organizations to increase donations, reduce fundraising costs, improve communications with constituents, manage their finances and optimize internal operations. As of March 31, 2007, the Company had approximately 16,000 active customers distributed across multiple verticals within the nonprofit market including religion, education, foundations, health and human services, arts and cultural, public and societal benefits, environment and animal welfare and international foreign affairs.

2. Restatement of financial statements

During the preparation of the Company’s Form 10-Q as of and for the quarter ended March, 31, 2007, the Company determined that SEC Staff Accounting Bulletin No. 108 (“SAB 108”) was misapplied in connection with reporting its consolidated financial position and results of operations as of and for the period ended December 31, 2006. The Company is restating its financial statements for the years ended December 31, 2006, 2005 and 2004 to reflect the impact of this error correction in accordance with Financial Accounting Standards Board’s (“FASB”) 154, “Accounting Changes and Error Corrections,” in this Form 10-Q for the period ended March 31, 2007. There was no impact to total operating, investing or financing cash flows for the years ended December 31, 2006, 2005 and 2004 and for the three months ended March 31, 2006.

The Company has historically recognized maintenance and subscription revenue using a monthly convention rather than on an actual-days basis. The effect on the statements of operations of the difference between these two methods has been evaluated in the past and it was concluded that the impact was immaterial. However under SAB 108, the Company should have recorded a one-time adjustment to its retained earnings to correct for the cumulative impact of using the actual-days method.

Accordingly, the Company’s financial statements for the years ended 2006, 2005 and 2004 and the three months ended March 31, 2006 have been restated as follows:

		As reported								As restated
		March 31,								March 31,
(in thousands)		2006				Adjustments				2006
Statement of operations data
Maintenance revenue		$	19,199			$	(160	)		$	19,039
Subscriptions revenue			2,308				(20	)			2,288
Total revenue			43,732				(180	)			43,552
Gross profit			30,114				(180	)			29,934
Income from operations			9,216				(180	)			9,036
Income tax provision			3,654				(70	)			3,584
Net income			5,670				(110	)			5,560
Basic earnings per share			0.13				—				0.13
Diluted earnings per share			0.13				(0.01	)			0.12

Blackbaud, Inc.
Condensed notes to consolidated financial statements (continued)
March 31, 2007
(Unaudited)

		As reported								As restated
		December 31,								December 31,
(in thousands)		2006				Adjustments				2006
Statement of operations data
Maintenance revenue		$	81,335			$	(442	)		$	80,893
Subscriptions revenue			10,742				(137	)			10,605
Total revenue			191,959				(579	)			191,380
Gross profit			134,688				(579	)			134,109
Income from operations			47,709				(579	)			47,130
Income tax provision			18,499				(223	)			18,276
Net income			30,508				(356	)			30,152
Basic earnings per share			0.70				—				0.70
Diluted earnings per share			0.68				—				0.68
Balance sheet data
Deferred tax asset, current portion		$	4,129			$	1,189			$	5,318
Total current assets			110,442				1,189				111,631
Total assets			193,820				1,189				195,009
Deferred revenue			72,015				3,063				75,078
Total current liabilities			94,443				3,063				97,506
Total liabilities			96,588				3,063				99,651
Retained earnings			78,172				(1,874	)			76,298
Total liabilities and stockholders’ equity			193,820				1,189				195,009

		As reported								As restated
		December 31,								December 31,
(in thousands)		2005				Adjustments				2005
Statement of operations data
Maintenance revenue		$	71,308			$	(145	)		$	71,163
Subscriptions revenue			7,167				(202	)			6,965
Total revenue			166,296				(347	)			165,949
Gross profit			116,166				(347	)			115,819
Income from operations			45,724				(347	)			45,377
Income tax provision			13,344				(133	)			13,211
Net income			33,301				(214	)			33,087
Basic earnings per share			0.78				—				0.78
Diluted earnings per share			0.72				—				0.72
Balance sheet data
Deferred tax asset, current portion		$	7,600			$	965			$	8,565
Total current assets			64,601				965				65,566
Total assets			147,498				965				148,463
Deferred revenue			59,459				2,484				61,943
Total current liabilities			79,948				2,484				82,432
Total liabilities			81,227				2,484				83,711
Retained earnings			59,947				(1,519	)			58,428
Total liabilities and stockholders’ equity			147,498				965				148,463

Blackbaud, Inc.
Condensed notes to consolidated financial statements (continued)
March 31, 2007
(Unaudited)

		As reported								As restated
		December 31,								December 31,
(in thousands)		2004				Adjustments				2004
Statement of operations data
Maintenance revenue		$	63,231			$	(150	)		$	63,081
Subscriptions revenue			3,710				(24	)			3,686
Total revenue			139,437				(174	)			139,263
Gross profit			98,237				(174	)			98,063
Income from operations			19,157				(174	)			18,983
Income tax provision			6,931				(83	)			6,848
Net income			12,641				(91	)			12,550
Basic earnings per share			0.30				—				0.30
Diluted earnings per share			0.27				—				0.27

3. Summary of significant accounting policies

Unaudited interim financial statements

The interim consolidated financial statements as of March 31, 2007 and for the three months ended March 31, 2007 and 2006, have been prepared by the Company pursuant to the rules and regulations of the 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 operations, consolidated statements of cash flows and consolidated statements of stockholders’ equity and comprehensive income 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, 2006 has been derived from the audited consolidated financial statements at that date. Operating results for the three months ended March 31, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2007 or any other future period. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 and other forms filed with the SEC from time to time.

Basis of consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Use of estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions. These estimates and assumptions 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. Areas of the financial statements where estimates may have the most significant effect include revenue recognition, the allowance for sales returns and doubtful accounts, valuation of long-lived and intangible assets and goodwill, stock-based compensation and provision for income taxes and valuation of deferred tax assets. Changes in the facts or circumstances underlying these estimates could result in material changes and actual results could differ from these estimates.

Revenue recognition

The Company’s revenue is generated primarily by selling perpetual licenses or charging for the use of its software products and providing support, training, consulting, technical and other professional services for those products. The Company makes available certain of its software products for use in hosted application arrangements without licensing perpetual rights to the software (“hosted applications”). Additionally, the Company provides hosting services to customers

Blackbaud, Inc.
Condensed notes to consolidated financial statements (continued)
March 31, 2007
(Unaudited)

who have purchased perpetual rights to certain of its software products (“hosting services”). The Company recognizes revenue in accordance with:

	•		The American Institute of Certified Public Accountants Statements of Position (“SOP”) 97-2, “Software Revenue Recognition,” as modified by SOPs 98-4 and 98-9, as well as Technical Practice Aids issued from time to time by the American Institute of Certified Public Accountants,
	•		The SEC Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition in Financial Statements,”
	•		The Emerging Issues Task Force (“EITF”) Issue No. 00-03, “Application of AICPA Statement of Position 97-2 to Arrangements that Include the Right to Use Software Stored on Another Entity’s Hardware”, and
	•		The EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.”

The Company recognizes revenue from the sale of perpetual software license rights when persuasive evidence of an arrangement exists, the product has been delivered, title and risk of loss have transferred to the customers, the fee is fixed or determinable and collection of the resulting receivable is probable. The Company deems acceptance of an agreement to be evidence of an arrangement. Delivery occurs when the product is delivered. The Company’s typical license agreement does not include customer acceptance provisions; if acceptance provisions are provided, delivery is deemed to occur upon acceptance. The Company considers the fee to be fixed or determinable unless the fee is subject to refund or adjustment or is not payable within the Company’s standard payment terms. The Company considers payment terms greater than 90 days to be beyond its customary payment terms. The Company deems collection probable if the Company expects that the customer will be able to pay amounts under the arrangement as they become due. If the Company determines that collection is not probable, the Company postpones recognition of the revenue until cash collection. The Company sells software licenses with maintenance and, often times, professional services. The Company allocates revenue to delivered components, normally the license component of the arrangement, using the residual value method based on objective evidence of the fair value of the undelivered elements, which is specific to the Company. Fair value for the maintenance services associated with the Company’s software licenses is based upon renewal rates stated in the Company’s agreements, which vary according to the level of the maintenance program. Fair value of professional services and other products and services is based on sales of these products and services to other customers when sold on a stand-alone basis.

The Company’s consulting, installation and implementation services are generally billed based on hourly rates plus reimbursable travel-related expenses. For small service engagements, less than approximately $10,000, the Company frequently contracts for and bills based on a fixed fee plus reimbursable travel-related expenses. The Company recognizes this revenue upon completion of the work performed. When the Company’s services include software customization, these services are provided to support customer requests for assistance in creating special reports and other minor enhancements that will assist with efforts to improve operational efficiency and/or to support business process improvements. These services are not essential to the functionality of the Company’s software and rarely exceed three months in duration. The Company recognizes revenue as these services are performed.

The Company recognizes analytic services revenue from donor prospect research engagements, the sale of lists of potential donors, benchmarking studies and data modeling service engagements upon delivery.

The Company sells training at a fixed rate for each specific class, at a per attendee price, or at a packaged price for several attendees, and revenue is recognized only upon the customer attending and completing training. Additionally, the Company sells a fixed-rate program, which permits customers to attend unlimited training over a specified contract period, typically one year, subject to certain restrictions. This revenue is recognized ratably over the contract period, which is typically one year.

The Company recognizes revenue from maintenance services ratably over the contract term, which is principally one year. Maintenance revenue also includes the right to unspecified product upgrades on an if-and-when available basis. Certain support services are sold in prepaid units of time and recognized as revenue upon their usage.

Subscription revenue includes revenue associated with hosted applications, hosting services, data enrichment services and online training programs. Subscription-based revenue and any related set-up fees are recognized ratably over the service period of the contract.

To the extent that the Company’s customers are billed and/or pay for the above described services in advance of delivery, the amounts are recorded in deferred revenue.

Blackbaud, Inc.
Condensed notes to consolidated financial statements (continued)
March 31, 2007
(Unaudited)

Stock-based compensation

Effective January 1, 2006, the Company adopted the provisions of the FASB’s Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment” (“SFAS No.123(R)”), using the modified prospective application method. SFAS No. 123(R) replaced SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), and superseded Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”). Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which is the vesting period. The provisions of SFAS No. 123(R) apply to grants made after the adoption date, awards modified, repurchased or cancelled after the adoption date and existing grants which were partially unvested at that date. Compensation expense for grants outstanding on the date of adoption is recognized over the remaining service period using the grant date fair values and amortization methods determined previously for the SFAS No. 123 pro forma disclosures.

No new stock options were issued in the three months ended March 31, 2007. During the three months ended March 31, 2007, 4,319 shares of restricted stock and 89,794 stock appreciation rights were granted. The aggregate grant date fair value of awards issued during the period was $750,000, which will be recognized as expense over the requisite service period of the awards.

Stock-based compensation expense is allocated to expense categories on the statements of operations. The following table summarizes stock-based compensation for the three months ended March 31, 2007 and 2006.

		Three months ended March 31,
(in thousands)		2007				2006
Included in cost of revenue:
Cost of services		$	157			$	140
Cost of maintenance			47				29
Cost of subscriptions			10				4
Total included in cost of revenue			214				173
Included in operating expenses:
Sales and marketing			260				220
Research and development			269				191
General and administrative			969				1,390
Total included in operating expenses			1,498				1,801
Total		$	1,712			$	1,974

Blackbaud, Inc.
Condensed notes to consolidated financial statements (continued)
March 31, 2007
(Unaudited)

Amortization expense

Amortization expense related to intangible assets acquired in business combinations is allocated to expense categories on the statements of operations. The following table summarizes amortization expense for the three months ended March 31, 2007 and 2006.

		Three months ended March 31,
(in thousands)		2007				2006
Included in cost of revenue:
Cost of license fees		$	24			$	—
Cost of services			221				—
Cost of maintenance			78				—
Cost of subscriptions			189				—
Cost of other revenue			16				—
Total included in cost of revenue			528				—
Included in operating expenses			84				129
Total		$	612			$	129

Income taxes

Prior to October 13, 1999, the Company was organized as an S corporation under the Internal Revenue Code and, therefore, was not subject to federal income taxes. The Company historically made distributions to its stockholders to cover the stockholders’ anticipated tax liability. In connection with its 1999 recapitalization, the Company converted its U.S. taxable status from an S corporation to a C corporation and, accordingly, since October 14, 1999 has been subject to federal and state income taxes. Upon this conversion and as a result of the recapitalization, the Company recorded a one-time benefit of $107,000,000 to establish a deferred tax asset. This amount was recorded as a direct increase to equity in the statements of stockholders’ equity. The Company has not recorded a valuation allowance against this item in its deferred tax asset as of March 31, 2007 or December 31, 2006, as the Company believes it will be able to utilize this benefit, which is dependent upon the Company’s ability to generate taxable income.

The Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109, Accounting for Income Taxes,” (“FIN 48”) on January 1, 2007. Under FIN 48 the tax benefit from an uncertain tax position must be recognized only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. Penalties and interest accrued related to unrecognized tax benefits are recognized in the provision for income taxes. The disclosure requirements and cumulative effect of adoption of FIN 48 are presented in Note 10.

Significant judgment is required in determining the provision for income taxes. The Company records its tax provision at the anticipated tax rates based on estimates of annual pretax income. To the extent that the final results differ from these estimated amounts that were initially recorded, such differences will impact the income tax provision in the period in which such determination is made and could have an impact on the deferred tax asset. The Company’s deferred tax assets and liabilities are recorded at an amount based upon a U.S. federal income tax rate of 35.0%. This U.S. federal income tax rate is based on the Company’s expectation that the Company’s deductible and taxable temporary differences will reverse over a period of years during which the Company will have annual taxable income exceeding $10,000,000 per year. If the Company’s results of operations fall below that threshold in the future, the Company will adjust its deferred tax assets and liabilities to an amount reflecting a reduced expected U.S. federal income tax rate, consistent with the corresponding expectation of lower taxable income. If such change is determined to be appropriate, it will affect the provision for income taxes during the period that the determination is made.

Blackbaud, Inc.
Condensed notes to consolidated financial statements (continued)
March 31, 2007
(Unaudited)

New accounting pronouncements

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Liabilities, including an amendment of FASB Statement No. 115” (“SFAS No. 159”). SFAS No. 159 permits entities to choose, at specified election dates, to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Unrealized gains and losses shall be reported on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS No. 157 “Fair Value Measurements” (“SFAS No. 157”). The Company is still assessing the impact of the adoption of SFAS No. 159 on its consolidated financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS No. 157”) which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS No. 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Earlier adoption is permitted, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. The Company does not expect the adoption of SFAS No. 157 to have a material impact on its consolidated financial position, results of operations or cash flows.

4. Business combination

On January 16, 2007, the Company acquired Target Software, Inc. and Target Analysis Group, Inc., or the Target Companies, privately-owned affiliated companies based in Cambridge, Massachusetts. The two acquired companies provide solutions that help organizations analyze, plan, forecast, execute, and manage high-volume fundraising campaigns while simultaneously helping them maintain long-term donor relationships. The acquisition of the Target Companies is expected to significantly advance the Company’s strategic goal of providing a complete solution for meeting the fundraising and direct marketing needs of the nonprofit sector. The Target Companies were acquired for approximately $58,705,000, including direct acquisition-related costs, in an all cash transaction that was financed by a combination of cash on hand and borrowings under the Company’s credit facility. An additional amount of up to $2,400,000 is contingently payable to the sellers under an earn-out arrangement based upon performance of the acquired businesses over the next year. The results of operations of the Target Companies are included in the consolidated financial statements of the Company from the date of acquisition.

As of March 31, 2007, the purchase accounting for this acquisition is still subject to final adjustment primarily for amounts allocated to other intangible assets based on preliminary valuation studies performed by a third-party valuation expert. The following table summarizes the preliminary allocation of the purchase price to the estimated fair values of the assets acquired and liabilities assumed in the acquisition of the Target Companies (in thousands):

Cash and cash equivalents		$	507
Accounts receivable			5,178
Other current assets			168
Property and equipment			2,291
Deferred tax assets			738
Intangible assets			22,323
Goodwill			37,193
Trade accounts payable			(611	)
Accrued expenses and other current liabilities			(3,844	)
Deferred revenue, current and noncurrent			(1,807	)
Amounts due to stockholders, current			(1,921	)
Capital lease obligations, current and noncurrent			(1,510	)
Total purchase price		$	58,705

Blackbaud, Inc.
Condensed notes to consolidated financial statements (continued)
March 31, 2007
(Unaudited)

The acquisition resulted in the identification of $22,323,000 of intangible assets, all of which are subject to amortization. The following table presents the amounts assigned to each intangible asset class:

						Weighted
						average
		Intangible				amortization
		assets acquired				period
		(in thousands)				(in years)
Customer relationships		$	13,627				12.7
Software			3,655				10.0
Database			3,441				8.0
Marketing assets			800				5.0
Noncompetition agreements			800				5.0
Total		$	22,323				11.0

The following unaudited pro forma information presents the consolidated results of operations of the Company as if the acquisition of the Target Companies had taken place at the beginning of 2007 and 2006. The pro forma information includes the business combination effect of the amortization charges from acquired intangible assets, adjustments to interest income and related tax effects. The pro forma information does not necessarily reflect the actual results that would have occurred nor is it necessarily indicative of future results of operations.

		Three months ended March 31,
		2007				2006
(in thousands, except per share amounts)						(Restated)
Revenue		$	55,926			$	47,695
Net income			5,504				4,389
Earnings per share, basic		$	0.13			$	0.10
Earnings per share, diluted			0.12				0.10

5. Earnings per share

The Company computes earnings per common share in accordance with SFAS Statement No. 128, “Earnings per Share” (“SFAS No. 128”). Under the provisions of SFAS No. 128, basic earnings per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding. Diluted earnings 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 then outstanding. Diluted earnings per share reflect the assumed conversion of all dilutive securities, using the treasury stock method. Dilutive potential common shares consist of shares issuable upon the exercise of stock options and shares of non-vested restricted stock.

Diluted earnings per share for the three months ended March 31, 2007 and 2006 includes the effect of 1,170,524 and 1,716,306 potential common shares, respectively, as they are dilutive. There were no anti-dilutive potential common shares outstanding for the three months ended March 31, 2007 and 2006.

Blackbaud, Inc.
Condensed notes to consolidated financial statements (continued)
March 31, 2007
(Unaudited)

The following table sets forth the computation of basic and diluted earnings per share:

		Three months ended March 31,
		2007				2006
(in thousands, except share and per share amounts)						(Restated)
Numerator:
Net income, as reported		$	5,756			$	5,560
Denominator:
Weighted average common shares			43,662,569				42,883,929
Add effect of dilutive securities:
Employee stock options and restricted stock			1,170,524				1,716,306
Weighted average common shares assuming dilution			44,833,093				44,600,235
Earnings per share:
Basic		$	0.13			$	0.13
Diluted		$	0.13			$	0.12

6. Prepaid expenses and other current assets

Prepaid expenses and other current assets consisted of the following as of March 31, 2007 and December 31, 2006:

		March 31,				December 31,
(in thousands)		2007				2006
Prepaid rent		$	178			$	187
Deferred sales commissions			982				588
Prepaid insurance			290				439
Prepaid software maintenance and royalties			1,665				1,633
Taxes, prepaid and receivable			3,503				4,986
Other			995				674
Total prepaid expenses and other current assets		$	7,613			$	8,507

Blackbaud, Inc.
Condensed notes to consolidated financial statements (continued)
March 31, 2007
(Unaudited)

7. Accrued expenses and other current liabilities

Accrued expenses and other current liabilities consisted of the following as of March 31, 2007 and December 31, 2006:

		March 31,				December 31,
(in thousands)		2007				2006
Accrued bonuses		$	2,656			$	4,599
Accrued commissions and salaries			1,724				1,954
Customer credit balances			1,163				1,060
Taxes payable			6,404				4,703
Accrued accounting and legal fees			1,261				1,278
Accrued health care costs			497				489
Other			2,926				1,964
Total accrued expenses and other current liabilities		$	16,631			$	16,047

8. Revolving credit facility

On September 3, 2004, the Company entered into a $30,000,000 million revolving credit facility. Amounts borrowed under the $30,000,000 million revolving credit facility bear interest, at the Company’s option, at a variable rate based on either the prime rate, federal funds rate or LIBOR plus a margin of between 0.5% and 2.0% based on the Company’s consolidated leverage ratio as defined. Amounts outstanding under the facility are not secured by a lien on the Company’s assets, but are guaranteed by the Company’s operating subsidiaries and the facility is subject to covenants, including a maximum leverage ratio, minimum interest coverage ratio and minimum net worth.

In January 2007, the Company borrowed $30,000,000 under the credit facility in connection with the acquisition of the Target Companies. As of March 31, 2007, there was $20,000,000 in principal outstanding under the credit facility and the annual interest rate was 6.82%. The Company is currently in compliance with all covenants under the agreement. The termination date of the facility is September 30, 2007.

9. Commitments and contingencies

The Company currently leases various office space and equipment under operating leases. In addition to operating leases, the Company, through its acquisition of the Target Companies, has various non-cancellable capital leases for computer equipment and furniture. The future minimum lease commitments related to these lease agreements, as well as the lease agreements discussed below, net of related sublease commitments, are as follows:

Year ending December 31,		Operating				Capital
(in thousands)		leases				leases
2007		$	5,370			$	465
2008			6,852				583
2009			7,199				387
2010			4,092				166
2011 and thereafter			217				39
Total minimum lease payments		$	23,730			$	1,640
Less: portion representing interest							222
Present value of net minimum lease payments							1,418
Less: current portion							488
Long-term portion						$	930

Blackbaud, Inc.
Condensed notes to consolidated financial statements (continued)
March 31, 2007
(Unaudited)

Lease agreement

On October 13, 1999, the Company entered into a lease agreement for office space with Duck Pond Creek, LLC, which is owned by certain current and former minority stockholders of the Company. The term of the lease is for ten years with two five-year renewal options by the Company. The current annual base rent of the lease is $4,809,000 payable in equal monthly installments. The base rate escalates annually at a rate equal to the change in the consumer price index, as defined in the agreement.

The Company has subleased a portion of its headquarters facility under various agreements extending through 2008. Under these agreements, rent expense was reduced by $108,000 and $121,000 for the three months ended March 31, 2007 and 2006, respectively. The operating lease commitments will be reduced by minimum aggregate sublease commitments of $350,000 and $128,000 for the years 2007 and 2008, respectively. The Company has also received and expects to receive through 2015, quarterly South Carolina state incentive payments as a result of locating its headquarters facility in Berkeley County, South Carolina. These amounts are recorded as a reduction of rent expense and were $364,000 and $427,000 for the three months ended March 31, 2007 and 2006, respectively.

Other commitments

The Company has a commitment of $200,000 payable annually through 2009 for certain naming rights on a stadium in Charleston, South Carolina. The Company incurred expense under this agreement of $50,000 for each of the three-month periods ended March 31, 2007 and 2006.

The Company utilizes third-party relationships in conjunction with its products. The contractual arrangements vary in length from two to four years. In certain cases, these arrangements require a minimum annual purchase commitment. The aggregate minimum purchase commitment under these arrangements at March 31, 2007 is approximately $864,000 through 2009. The Company incurred expense under these arrangements of $195,000 and $129,000 for the three months ended March 31, 2007 and 2006, respectively.

Legal contingencies

The Company is subject to legal proceedings and claims which have arisen in the ordinary course of business. The Company does not believe the amount of potential liability with respect to these actions will have a material adverse effect upon the Company’s financial position or results of operations.

10. Income taxes

Income taxes for the three-month period ended March 31, 2007 were calculated using the projected effective tax rate for fiscal 2007 in accordance with SFAS No. 109. The 2007 estimated annual effective tax rate of 39.2%, which excludes period-specific items, was applied as the effective rate for the quarter ended March 31, 2007. The Company’s effective tax rates for the three-month periods ended March 31, 2007 and 2006 was 37.5% and 39.2%, respectively. As of March 31, 2007, the Company had state tax credits of $10,142,000, $6,592,000 net of federal tax effect, which will expire between 2009 and 2020, if unused. These tax credits had a valuation reserve of approximately $4,917,000, $3,191,000 net of federal tax effect, as of December 31, 2006. During the three months ended March 31, 2007, the valuation allowance was increased $83,000 for state credits that are expected to expire unused.

Excess tax benefits on stock option exercises of approximately $446,000 and $2,924,000 were recorded in stockholders’ equity in the three months ended March 31, 2007 and 2006, respectively.

The Company adopted the provisions of FIN 48 on January 1, 2007. As a result, the Company recognized a $269,000 reduction, including interest and penalties and net of applicable taxes, to the January 1, 2007 balance of retained earnings. The amount of the Company’s unrecognized tax benefits as of January 1, 2007 was $642,000, of which $417,000 would impact the effective rate of the Company if recognized. As of the date of adoption, the total amount of accrued interest and penalties was $334,000. No significant change in the gross amount of unrecognized tax benefits is expected within the next 12 months. In the three months ended March 31, 2007, changes in accrued interest, penalties and unrecognized tax benefits as a result of tax positions taken in current and prior years were insignificant.

Blackbaud, Inc.
Condensed notes to consolidated financial statements (continued)
March 31, 2007
(Unaudited)

The Company recognizes penalties and interest accrued related to unrecognized tax benefits in the provision for income taxes.

The Company files U.S. federal, state and certain foreign country tax returns. None of the Company’s tax returns are currently under examination by tax authorities. The statute of limitations for examinations of our U.S. federal and most other returns is open for tax years 2003 through our most recent filings.

11. Stockholders’ equity

Preferred stock

The Company has authorized 20,000,000 shares of preferred stock. No shares were issued and outstanding at March 31, 2007 and December 31, 2006. The Company’s Board of Directors may fix the relative rights and preferences of each series of preferred stock in a resolution of the Board of Directors.

Dividends

On February 2, 2007, the Company’s Board of Directors approved an increase to the Company’s annual dividend from $0.28 per share to $0.34 per share and declared its first quarter dividend of $0.085 per share, which was paid on March 15, 2007 to stockholders of record on February 28, 2007.

Stock repurchase program

On July 26, 2005, the Company’s Board of Directors approved a stock repurchase program that authorized the Company to purchase up to $35,000,000 of the Company’s outstanding shares of common stock. The shares could be purchased in conjunction with a public offering of the Company’s stock, from time to time on the open market or in privately negotiated transactions depending upon market conditions and other factors, all in accordance with the requirements of applicable law. In the three months ended March 31, 2007, the Company repurchased 620,878 shares under this program at an average price per share of $22.64. The Company accounts for purchases of treasury stock under the cost method which resulted in an increase to the treasury stock balance of $14,079,000 as of March 31, 2007. This plan was still in effect at March 31, 2007. The remaining amount available to purchase stock under this plan was $6,181,000 as of March 31, 2007.

In addition to the Company’s stock repurchase plan, 1,190 shares, totaling $26,000, were purchased from restricted stock holders to satisfy their tax obligations due upon vesting of restricted stock during the three months ended March 31, 2007.

12. Segment information

The Company has adopted SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS No. 131”). SFAS No. 131 establishes standards for the reporting by business enterprises of information about operating segments, products and services, geographic areas and major customers. The method of determining what information is reported is based on the way that management organizes the operating segments within the Company for making operational decisions and assessments of financial performance. The Company has determined that its reportable segments are those that are based upon internal financial reports that disaggregate operating information into various reportable segments. The Company’s chief operating decision maker, as defined in SFAS No. 131, is its chief executive officer, or CEO.

Blackbaud, Inc.
Condensed notes to consolidated financial statements (continued)
March 31, 2007
(Unaudited)

The CEO uses the information presented in these reports to make certain operating decisions. The CEO does not review any report presenting segment balance sheet information. The segment revenues and direct controllable costs, which include salaries, related human resource costs, travel-related costs, third-party contractors, data expense, classroom rentals and other direct costs, for the three months ended March 31, 2007 and 2006 were as follows:

						Consulting and
						education				Analytic
(in thousands)		License fees				services (1)				services (2)				Maintenance				Subscriptions				Other				Total
Three months ended March 31, 2007
Revenue		$	8,067			$	15,346			$	2,968			$	22,436			$	4,793			$	1,535			$	55,145
Direct controllable costs			452				8,881				1,519				3,154				1,475				1,340				16,821
Segment income			7,615				6,465				1,449				19,282				3,318				195				38,324
Corporate costs not allocated																											3,074
Operating expenses																											25,972
Interest (income) expense																											(4	)
Other expense (income), net																											69
Income before provision for income taxes																										$	9,213
Three months ended March 31, 2006 (Restated)
Revenue		$	7,221			$	12,548			$	1,166			$	19,039			$	2,288			$	1,290			$	43,552
Direct controllable costs			670				6,314				819				2,609				478				1,086				11,976
Segment income			6,551				6,234				347				16,430				1,810				204				31,576
Corporate costs not allocated																											1,642
Operating expenses																											20,898
Interest (income) expense																											(137	)
Other expense (income), net																											29
Income before provision for income taxes																										$	9,144

(1) This segment consists of consulting, installation and implementation, document imaging, customer training and other education services.

(2) This segment consists of donor prospect research engagements, sales of lists of potential donors, benchmarking studies and data modeling services.

13. Subsequent events

On May 1, 2007, the Company’s Board of Directors declared a second quarter dividend of $0.085 per share payable on June 15, 2007 to stockholders of record on May 28, 2007.

Blackbaud, Inc.

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. This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements reflect our current view with respect to future events and financial performance and are subject to risks and uncertainties, including those set forth under “Cautionary statement” included in this “Management’s discussion and analysis of financial condition and results of operations” and elsewhere in this report, that could cause actual results to differ materially from historical or anticipated results.

Overview

We are the leading global provider of software and related services designed specifically for nonprofit organizations. Our products and services enable nonprofit organizations to increase donations, reduce fundraising costs, improve communications with constituents, manage finances and optimize internal operations. We have focused solely on the nonprofit market since our incorporation in 1982 and have developed our suite of products and services based upon our extensive knowledge of the operating challenges facing nonprofit organizations. As of March 31, 2007, we had approximately 16,000 customers. Our customers operate in multiple verticals within the nonprofit market, including religion, education, foundations, health and human services, arts and cultural, public and societal benefits, environment and animal welfare and international foreign affairs.

We derive revenue from selling perpetual licenses or charging for the use of our software products and providing a broad offering of services, including consulting, training, installation, implementation, as well as ongoing customer support and maintenance. Consulting, training and implementation are generally not essential to the functionality of our software products and are sold separately. Furthermore, we derive revenue from providing hosting services, performing donor prospect research engagements, selling lists of potential donors, providing benchmarking studies and data modeling services.

Restatement of financial statements

During the preparation of the our Form 10-Q as of and for the quarter ended March, 31, 2007, we determined that SAB 108 was misapplied in connection with reporting our consolidated financial position and results of operations as of and for the period ended December 31, 2006. As a result, we are restating our financial statements to reflect the impact of this error correction, in accordance with Financial Accounting Standards Board’s (“FASB”) 154, “Accounting Changes and Error Corrections.” The results of operations for the three months ended March 31, 2006 included in the following discussion and analysis have been restated to reflect the impact of this error correction.

Critical accounting policies and estimates

Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, the reported amounts of revenue and expenses during the reporting period and related disclosures of contingent assets and liabilities. The most significant estimates and assumptions relate to our revenue recognition, our allowance for sales returns and doubtful accounts, valuation of long-lived and intangible assets and goodwill, stock-based compensation and provision for income taxes and valuation of deferred tax assets.

We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. On an ongoing basis, we reconsider and evaluate our estimates and assumptions. We are not aware of any circumstances in the past that have caused these estimates and assumptions to be materially wrong. Furthermore, we are not currently aware of any material changes in our business that might cause these assumptions or estimates to differ significantly. In our discussion below of deferred taxes, the most significant asset subject to such assumptions and estimates, we have described the sensitivity of these assumptions or estimates to potential deviations in actual results. Actual results could differ from any of our estimates under different assumptions or conditions.

Blackbaud, Inc.

Item 2. Management’s discussion and analysis of financial condition and results of operations (continued)

We believe the critical accounting policies listed below affect significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue recognition

Our revenue is generated primarily by selling perpetual licenses or charging for the use of our software products and providing support, training, consulting, technical and other professional services for those products. We make available certain software products for use in hosted application arrangements without licensing perpetual rights to the software (“hosted applications”). Additionally we provide hosting services to customers who have purchased perpetual rights to our software products (“hosting services”). We recognize revenue in accordance with:

	•		The American Institute of Certified Public Accountants Statements of Position (“SOP”) 97-2, “Software Revenue Recognition,” as modified by SOPs 98-4 and 98-9, as well as Technical Practice Aids issued from time to time by the American Institute of Certified Public Accountants,
	•		The SEC Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition in Financial Statements,”
	•		The Emerging Issues Task Force (“EITF”) Issue No. 00-03, “Application of AICPA Statement of Position 97-2 to Arrangements that Include the Right to Use Software Stored on Another Entity’s Hardware” and
	•		The EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.”

We recognize revenue from the sale of perpetual license rights to software when persuasive evidence of an arrangement exists, the product has been delivered, title and risk of loss have transferred to the customers, the fee is fixed or determinable and collection of the resulting receivable is probable. We deem acceptance of an agreement to be evidence of an arrangement. Delivery occurs when the product is delivered. Our typical license agreement does not include customer acceptance provisions; if acceptance provisions are provided, delivery is deemed to occur upon acceptance. We consider the fee to be fixed or determinable unless the fee is subject to refund or adjustment or is not payable within the our standard payment terms. We consider payment terms greater than 90 days to be beyond its customary payment terms. We deem collection probable if we expect that the customer will be able to pay amounts under the arrangement as they become due. If we determine that collection is not probable, we postpone recognition of the revenue until cash collection. We sell software licenses with maintenance and, often times, professional services. We allocate revenue to delivered components, normally the license component of the arrangement, using the residual value method based on objective evidence of the fair value of the undelivered elements, which is specific to us. Fair value for the maintenance services associated with our software licenses is based upon renewal rates stated in our agreements, which vary according to the level of the maintenance program. Fair value of professional services and other products and services is based on sales of these products and services to other customers when sold on a stand-alone basis.

The application of SOP 97-2 requires judgment, including whether a software arrangement includes multiple elements, and if so, whether vendor-specific objective evidence (“VSOE”) of fair value exists for those elements. As we develop new products, we may experience difficulty in determining VSOE regarding the fair value of those new products. This would result in the deferral of revenue on those transactions until all elements of the arrangement have been delivered or until VSOE is established.

Our services, which include consulting, installation and implementation services, are generally billed based on hourly rates plus reimbursable travel-related expenses. For small service engagements, less than approximately $10,000, we frequently contract for and bill based on a fixed fee plus reimbursable travel-related expenses. We recognize this revenue upon completion of the work performed. When our services include software customization, these services are provided to support customer requests for assistance in creating special reports and other minor enhancements that will assist with efforts to improve operational efficiency and/or to support business process improvements. These services are not essential to the functionality of our software and rarely exceed three months in duration. We recognize revenue as these services are performed.

We recognize analytic services revenue from donor prospect research engagements, sale of lists of potential donors, benchmarking studies and data modeling service engagements upon delivery.

We sell training at a fixed rate for each specific class, at a per attendee price, or at a packaged price for several attendees, and revenue is recognized only upon the customer attending and completing training. Additionally, we sell a fixed-rate program, which permits customers to attend unlimited training over a specified contract period, typically one year, subject to certain restrictions. This revenue is recognized ratably over the contract period, which is typically one year.

Blackbaud, Inc.

Item 2. Management’s discussion and analysis of financial condition and results of operations (continued)

We recognize revenue from maintenance services ratably over the contract term, which is principally one year. Maintenance revenue also includes the right to unspecified product upgrades on an if-and-when available basis. Certain support services are sold in prepaid units of time and recognized as revenue upon their usage.

Subscription revenue includes revenue associated with hosted applications, hosting services, data enrichment services and online training programs. Subscription-based revenue and any related set-up fees are recognized ratably over the service period of the contract.

To the extent that our customers are billed and/or pay for the above described services in advance of delivery, the amounts are recorded in deferred revenue.

Sales returns and allowance for doubtful accounts

We provide customers a 30-day right of return and maintain a reserve for returns. We estimate the amount of this reserve based on historical experience. Provisions for sales returns are charged against the related revenue items.

We maintain an allowance for doubtful accounts at an amount we estimate to be sufficient to provide adequate protection against losses resulting from extending credit to our customers. In judging the adequacy of the allowance for doubtful accounts, we consider multiple factors including historical bad debt experience, the general economic environment, the need for specific customer reserves and the aging of our receivables. Any necessary provision is reflected in general and administrative expense. A considerable amount of judgment is required in assessing these factors and if any receivables were to deteriorate, an additional provision for doubtful accounts could be required.

Valuation of long-lived and intangible assets and goodwill

We review identifiable intangible and other long-lived assets for impairment when events change or circumstances indicate the carrying amount may not be recoverable. Events or changes in circumstances that indicate the carrying amount may not be recoverable include, but are not limited to, a significant decrease in the market value of the business or asset acquired, a significant adverse change in the extent or manner in which the business or asset acquired is used or significant adverse change in the business climate. If such events or changes in circumstances occur, we use the undiscounted cash flow method to determine whether the asset is impaired. Cash flows would include the estimated terminal value of the asset and exclude any interest charges. To the extent that the carrying value of the asset exceeds the undiscounted cash flows over the estimated remaining life of the asset, we measure the impairment using discounted cash flows. The discount rate utilized would be based on our best estimate of our risks and required investment returns at the time the impairment assessment is made.

In accordance with FASB’s Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), we test goodwill for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test compares the fair value of the reporting unit with its carrying amount. If the carrying amount exceeds its fair value, impairment is indicated. The impairment is measured as the excess of the recorded goodwill over its fair value, which could materially adversely impact our financial position and results of operations. Goodwill is assigned to various reporting units.

Stock-based compensation

Effective January 1, 2006, we adopted the provisions of the FASB’s Statement No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”), using the modified prospective application method. SFAS No. 123(R) replaced SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”) and supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”). Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which is the vesting period. Under the modified prospective application method, prior periods are not revised for comparative purposes. The provisions of SFAS No. 123(R) apply to grants made after the adoption date and existing grants which were partially unvested at that date. Compensation expense for grants outstanding on the date of adoption are recognized over the remaining service period using the grant date fair values and amortization methods determined previously for the SFAS No. 123 pro forma disclosures.

Blackbaud, Inc.

Item 2. Management’s discussion and analysis of financial condition and results of operations (continued)

Provision for income tax and valuation of deferred tax assets

We account for income taxes using the asset and liability approach as prescribed by SFAS Statement No. 109, “Accounting for Income Taxes.” This approach requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or income tax returns. Using the enacted tax rates in effect for the year in which we expect the differences to reverse, we determine deferred tax assets and liabilities based on the differences between the financial reporting and the tax basis of an asset or liability. We record a valuation allowance when it is more likely than not that the deferred tax asset will not be realized.

Significant judgment is required in determining our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in a net deferred tax asset, which is included on our consolidated balance sheets. The final tax outcome of these matters might be different than that which is reflected in our historical income tax provisions, benefits and accruals. Any difference could have a material effect on our income tax provision and net income in the period in which such a determination is made.

Prior to October 13, 1999, we were organized as an S corporation under the Internal Revenue Code and, therefore, were not subject to federal income taxes. In addition, we were not subject to income tax in many of the states in which we operated as a result of our S corporation status. We historically made distributions to our stockholders to cover the stockholders’ anticipated tax liability. In connection with our 1999 recapitalization (see Note 3 to the consolidated financial statements), we converted our U.S. taxable status from an S corporation to a C corporation. Accordingly, since October 14, 1999 we have been subject to federal and state income taxes. Upon the conversion and in connection with the recapitalization, we recorded a one-time benefit of $107.0 million to establish a deferred tax asset as a result of the recapitalization agreement.

We must assess the likelihood that the net deferred tax asset will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance; we must include an expense within the tax provision in the statement of operations. Except with respect to certain state income tax credits, we have not recorded a valuation allowance as of March 31, 2007 and December 31, 2006, because we expect to be able to utilize our entire net deferred tax asset. The ability to utilize our net deferred tax asset is solely dependent on our ability to generate future taxable income. Based on current estimates of revenue and expenses, we expect future taxable income will be more than sufficient to recover the annual amount of additional tax deductions permitted. Even if actual results are significantly below our current estimates, the recovery still remains likely and no valuation allowance would be necessary.

Significant judgment is required in determining the provision for income taxes. To the extent that the final results differ from these estimated amounts that were initially recorded, such differences will impact the income tax provision in the period in which such determination is made and could have an impact on the deferred tax asset. Our deferred tax assets and liabilities are recorded at an amount based upon a blended U.S. federal income tax rate of 35.0%. This U.S. federal income tax rate is based on our expectation that deductible and taxable temporary differences will reverse over a period of years during which we will have annual taxable income exceeding $10.0 million per year. If our results of operations fall below that threshold in the future, we will adjust its deferred tax assets and liabilities to an amount reflecting a reduced expected U.S. federal income tax rate, consistent with the corresponding expectation of lower taxable income. If such change is determined to be appropriate, it will affect the provision for income taxes during the period that the determination is made.

We adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109, Accounting for Income Taxes,” (“FIN 48”) on January 1, 2007. Under FIN 48 we must recognize the tax impact from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax impact recognized in the financial statements from such a position is measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. Penalties and interest related to uncertain tax positions are recorded as tax expense.

Contingencies

We are subject to the possibility of various loss contingencies in the normal course of business. We accrue for loss contingencies when a loss is estimable and probable.

Blackbaud, Inc.

Item 2. Management’s discussion and analysis of financial condition and results of operations (continued)

Results of operations

The following table sets forth our consolidated statements of operations data expressed as a percentage of total revenue for the periods indicated.

		Three months ended March 31,
		2007				2006
						(Restated)
Revenue
License fees			14.6	%			16.6	%
Services			33.2				31.5
Maintenance			40.7				43.7
Subscriptions			8.7				5.2
Other revenue			2.8				3.0
Total revenue			100.0	%			100.0	%
Cost of revenue
Cost of license fees			0.9				1.5
Cost of services			22.0				18.6
Cost of maintenance			7.3				7.4
Cost of subscriptions			3.4				1.3
Cost of other revenue			2.5				2.5
Total cost of revenue			36.1				31.3
Gross profit			63.9				68.7
Operating expenses
Sales and marketing			23.4				21.4
Research and development			12.4				13.8
General and administrative			11.1				12.5
Amortization			0.2				0.3
Total operating expenses			47.1				48.0
Income from operations			16.8				20.7
Interest income			0.7				0.3
Interest expense			(0.7	)			0.0
Other (expense) income, net			(0.1	)			0.0
Income before provision for income taxes			16.7				21.0
Income tax provision			6.3				8.2
Net income			10.4	%			12.8	%

Blackbaud, Inc.

Item 2. Management’s discussion and analysis of financial condition and results of operations (continued)

Comparison of the three months ended March 31, 2007 and 2006

We completed the acquisition of Target Software, Inc. and Target Analysis Group, Inc., together referred to as the Target Companies, on January 16, 2007. The results of operations from the Target Companies are included in our consolidated results of operations from the date of acquisition.

Revenue

The table below compares revenue from our statement of operations for the first three months of 2007 with the same period of 2006.

		Three months ended March 31,
		2007				2006
(in millions)		(Restated)								Change				% Change
License fees		$	8.1			$	7.2			$	0.9				13	%
Services			18.3				13.7				4.6				34	%
Maintenance			22.4				19.0				3.4				18	%
Subscriptions			4.8				2.3				2.5				109	%
Other			1.5				1.3				0.2				15	%
Total revenue		$	55.1			$	43.5			$	11.6				27	%

Total revenue increased $11.6 million, or 27%, in the first quarter of 2007 compared to the first quarter of 2006. A total of $4.2 million or 36% of this increase was attributable to the inclusion of the Target Companies in our consolidated results of operations. The remaining increase in revenue in the first quarter of 2007 is due to growth in services and license fees to new and existing customers as well as the introduction of new product offerings. Also contributing to the growth is revenue from new maintenance contracts associated with these new license agreements and existing client increases and revenue from our subscription offerings.

Segment results

We analyze our business according to our six operating segments as identified in Note 12, which are license fees, consulting and education services, analytic services, maintenance, subscriptions and other. The analysis provided below is presented before the inclusion of various allocable corporate costs such as depreciation, facilities and IT support costs, stock-based compensation and amortization because, in managing our operations, we believe such costs significantly affect our ability to better understand and manage other operating expenses and cash needs.

License fees

		Three months ended March 31,
(in millions)		2007				2006				Change				% Change
License fee revenue		$	8.1			$	7.2			$	0.9				13	%
Direct controllable cost of license fees			0.5				0.7				(0.2	)			(29	)%
Segment income		$	7.6			$	6.5			$	1.1				17	%
Segment margin %			94	%			90	%

Revenue from license fees is derived from the sale of our software products, under a perpetual license agreement. License fee revenue growth in the first quarter of 2007, which is primarily volume driven, is attributable to a $0.7 million increase in sales to existing clients and $0.1 million increase in product sales to new customers.

Direct controllable cost of license fees includes third-party software royalties, variable reseller commissions and costs of shipping software products to our customers. The decrease in cost of license fees in the first quarter of 2007 was primarily due to the elimination of reseller commissions that have declined by $0.1 million as a result of the discontinued use of that sales channel, together with reduced third-party royalty expense of $0.1 million associated with Patron Edge, our ticketing software.

License fee revenue growth together with the decrease in cost of license fees contributed to expansion of margin year over year.

Blackbaud, Inc.

Item 2. Management’s discussion and analysis of financial condition and results of operations (continued)

Consulting and education services

		Three months ended March 31,
(in millions)		2007				2006				Change				% Change
Consulting and education services revenue		$	15.3			$	12.5			$	2.8				22	%
Direct controllable cost of consulting and education services			8.9				6.3				2.6				41	%
Segment income		$	6.4			$	6.2			$	0.2				3	%
Segment margin %			42	%			50	%

Consulting and education services revenue consists of consulting, installation, implementation and education services. Consulting, installation and implementation services involve converting data from a customer’s existing system, assistance in file set up and system configuration, and/or process re-engineering. Education services involve customer training activities.

The rates charged for our service offerings have remained relatively constant year over year and, as such, the increase in revenue in the first quarter of 2007 is principally the result of increased volume of services provided. The increase in revenue is comprised of a $2.4 million increase in consulting, installation and implementation services delivered, of which $1.0 million is attributable to the Target Companies and a $0.4 million increase in education services delivered.

Cost of consulting and education services is principally comprised of human resource costs, third-party contractor expenses, classroom rentals and other costs incurred in providing consulting, installation and implementation services and customer training. During the first quarter of 2007, salary, benefit and bonus expense increased $1.8 million compared to the first quarter of 2006 as we increased headcount to meet growing customer demand. A total of $0.5 million, or 28%, of the increase in salary, benefits and bonus expense is due to additional headcount resulting from the Target Companies. Other increases include increased travel-related expenses, relocation and recruiting costs and services from contractors totaling $0.7 million associated with increased service delivery.

The margin decrease in the first quarter of 2007 compared to the first quarter of 2006 is primarily due to increased human resource costs related to our successful hiring efforts in 2007 and lower utilization as a result of a greater percentage of headcount being trained during the quarter compared to the prior year. Additionally, average billing rates for our consultants have remained relatively constant while consultants’ salaries and related human resource costs have increased year over year contributing to the margin decrease.

Analytic services

		Three months ended March 31,
(in millions)		2007				2006				Change				% Change
Analytic services revenue		$	3.0			$	1.2			$	1.8				150	%
Direct controllable cost of analytic services			1.5				0.8				0.7				88	%
Segment income		$	1.5			$	0.4			$	1.1				275	%
Segment margin %			50	%			33	%