Document

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 June 30, 2016
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
 
 
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.)

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  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).
YES  þ    NO  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer    þ
Accelerated filer                      
¨
Non-accelerated filer      ¨ (Do not check if a smaller reporting company)
Smaller reporting company    
¨
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES  ¨  NO  þ
The number of shares of the registrant’s Common Stock outstanding as of July 25, 2016 was 47,518,682.








TABLE OF CONTENTS

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Second Quarter 2016 Form 10-Q
1

Table of Contents

Blackbaud, Inc.

 
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, 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 “Item 1A. Risk factors” and elsewhere in this report, in our Annual Report on Form 10-K for the year ended December 31, 2015 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
Second Quarter 2016 Form 10-Q



 
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Blackbaud, Inc.
Consolidated Balance Sheets
(Unaudited)
(dollars in thousands)
June 30,
2016

December 31,
2015

Assets
 
 
Current assets:
 
 
Cash and cash equivalents
$
15,263

$
15,362

Restricted cash due to customers
195,034

255,038

Accounts receivable, net of allowance of $4,386 and $4,943 at June 30, 2016 and December 31, 2015, respectively
107,749

80,046

Prepaid expenses and other current assets
53,797

48,666

Total current assets
371,843

399,112

Property and equipment, net
54,144

52,651

Software development costs, net
27,793

19,551

Goodwill
436,012

436,449

Intangible assets, net
273,445

294,672

Other assets
21,847

20,901

Total assets
$
1,185,084

$
1,223,336

Liabilities and stockholders’ equity
 
 
Current liabilities:
 
 
Trade accounts payable
$
27,817

$
19,208

Accrued expenses and other current liabilities
44,739

57,461

Due to customers
195,034

255,038

Debt, current portion
4,375

4,375

Deferred revenue, current portion
250,449

230,216

Total current liabilities
522,414

566,298

Debt, net of current portion
398,865

403,712

Deferred tax liability
27,823

27,996

Deferred revenue, net of current portion
6,212

7,119

Other liabilities
8,102

7,623

Total liabilities
963,416

1,012,748

Commitments and contingencies (see Note 10)


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


Common stock, $0.001 par value; 180,000,000 shares authorized, 57,543,656 and 56,873,817 shares issued at June 30, 2016 and December 31, 2015, respectively
58

57

Additional paid-in capital
294,810

276,340

Treasury stock, at cost; 10,048,472 and 9,903,071 shares at June 30, 2016 and December 31, 2015, respectively
(207,898
)
(199,861
)
Accumulated other comprehensive loss
(1,640
)
(825
)
Retained earnings
136,338

134,877

Total stockholders’ equity
221,668

210,588

Total liabilities and stockholders’ equity
$
1,185,084

$
1,223,336

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

Second Quarter 2016 Form 10-Q
3




Blackbaud, Inc.
Consolidated statements of comprehensive income
(Unaudited)
(dollars in thousands, except per share amounts)
Three months ended 
 June 30,
 
 
Six months ended 
 June 30,
 
2016

2015

 
2016

2015

Revenue
 
 
 
 
 
Subscriptions
$
104,039

$
80,009

 
$
200,890

$
152,522

Maintenance
37,449

38,627

 
74,609

77,523

Services
35,419

33,667

 
67,833

64,973

License fees and other
3,284

3,956

 
6,115

8,234

Total revenue
180,191

156,259

 
349,447

303,252

Cost of revenue
 
 
 
 
 
Cost of subscriptions
52,142

39,400

 
101,814

75,578

Cost of maintenance
5,685

6,969

 
11,008

14,471

Cost of services
24,696

25,915

 
49,015

52,886

Cost of license fees and other
1,020

1,146

 
1,622

2,307

Total cost of revenue
83,543

73,430

 
163,459

145,242

Gross profit
96,648

82,829

 
185,988

158,010

Operating expenses
 
 
 
 
 
Sales, marketing and customer success
39,308

29,723

 
74,922

58,285

Research and development
22,578

20,166

 
45,357

41,442

General and administrative
19,857

17,955

 
39,613

34,798

Amortization
708

524

 
1,460

1,012

Total operating expenses
82,451

68,368

 
161,352

135,537

Income from operations
14,197

14,461

 
24,636

22,473

Interest expense
(2,721
)
(1,873
)
 
(5,396
)
(3,559
)
Other expense, net
(65
)
(1,274
)
 
(170
)
(1,561
)
Income before provision for income taxes
11,411

11,314

 
19,070

17,353

Income tax provision
3,598

4,272

 
6,262

6,026

Net income
$
7,813

$
7,042

 
$
12,808

$
11,327

Earnings per share
 
 
 
 
 
Basic
$
0.17

$
0.15

 
$
0.28

$
0.25

Diluted
$
0.17

$
0.15

 
$
0.27

$
0.24

Common shares and equivalents outstanding
 
 
 
 
 
Basic weighted average shares
46,083,055

45,579,345

 
46,047,788

45,554,645

Diluted weighted average shares
46,927,626

46,402,707

 
46,865,218

46,289,440

Dividends per share
$
0.12

$
0.12

 
$
0.24

$
0.24

Other comprehensive (loss) income
 
 
 
 
 
Foreign currency translation adjustment
(431
)
(196
)
 
(28
)
(522
)
Unrealized (loss) gain on derivative instruments, net of tax
(118
)
97

 
(787
)
(372
)
Total other comprehensive loss
(549
)
(99
)
 
(815
)
(894
)
Comprehensive income
$
7,264

$
6,943

 
$
11,993

$
10,433

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

4
Second Quarter 2016 Form 10-Q


Blackbaud, Inc.
Consolidated statements of cash flows
(Unaudited)
 
Six months ended 
 June 30,
 
(dollars in thousands)
2016

2015

Cash flows from operating activities
 
 
Net income
$
12,808

$
11,327

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Depreciation and amortization
35,549

27,272

Provision for doubtful accounts and sales returns
2,264

2,934

Stock-based compensation expense
15,787

11,413

Excess tax benefits from exercise and vesting of stock-based compensation
(2,729
)
(954
)
Deferred taxes
(129
)
(801
)
Loss on sale of business

1,976

Amortization of deferred financing costs and discount
478

420

Other non-cash adjustments
(429
)
289

Changes in operating assets and liabilities, net of acquisition and disposal of businesses:
 
 
Accounts receivable
(30,097
)
(13,355
)
Prepaid expenses and other assets
(6,011
)
(2,102
)
Trade accounts payable
8,857

5,235

Accrued expenses and other liabilities
(18,019
)
(9,882
)
Restricted cash due to customers
62,038

78,718

Due to customers
(62,038
)
(78,718
)
Deferred revenue
19,658

13,792

Net cash provided by operating activities
37,987

47,564

Cash flows from investing activities
 
 
Purchase of property and equipment
(12,569
)
(7,014
)
Capitalized software development costs
(12,168
)
(6,982
)
Purchase of net assets of acquired companies, net of cash
530


Net cash used in sale of business

(521
)
Net cash used in investing activities
(24,207
)
(14,517
)
Cash flows from financing activities
 
 
Proceeds from issuance of debt
120,900

70,100

Payments on debt
(126,088
)
(93,388
)
Proceeds from exercise of stock options
5

18

Excess tax benefits from exercise and vesting of stock-based compensation
2,729

954

Dividend payments to stockholders
(11,398
)
(11,255
)
Net cash used in financing activities
(13,852
)
(33,571
)
Effect of exchange rate on cash and cash equivalents
(27
)
(984
)
Net decrease in cash and cash equivalents
(99
)
(1,508
)
Cash and cash equivalents, beginning of period
15,362

14,735

Cash and cash equivalents, end of period
$
15,263

$
13,227

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

Second Quarter 2016 Form 10-Q
5


Blackbaud, Inc.
Consolidated statements of stockholders' equity
(Unaudited)
(dollars in thousands)
Common stock
 
Additional
paid-in
capital

Treasury
stock

Accumulated
other
comprehensive
loss

Retained
earnings

Total stockholders' equity

Shares

Amount

Balance at December 31, 2014
56,048,135

$
56

$
245,674

$
(190,440
)
$
(1,032
)
$
131,658

$
185,916

Net income





25,649

25,649

Payment of dividends





(22,508
)
(22,508
)
Exercise of stock options and stock appreciation rights and vesting of restricted stock units
202,078


32




32

Surrender of 163,017 shares upon vesting of restricted stock and restricted stock units and exercise of stock appreciation rights



(9,421
)


(9,421
)
Excess tax benefits from exercise and vesting of stock-based compensation


5,466




5,466

Stock-based compensation


25,168



78

25,246

Restricted stock grants
736,252

1





1

Restricted stock cancellations
(112,648
)






Other comprehensive income




207


207

Balance at December 31, 2015
56,873,817

$
57

$
276,340

$
(199,861
)
$
(825
)
$
134,877

$
210,588

Net income





12,808

12,808

Payment of dividends





(11,398
)
(11,398
)
Exercise of stock options and stock appreciation rights and vesting of restricted stock units
225,653


5




5

Surrender of 145,401 shares upon vesting of restricted stock and restricted stock units and exercise of stock appreciation rights



(8,037
)


(8,037
)
Excess tax benefits from exercise and vesting of stock-based compensation


2,729




2,729

Stock-based compensation


15,736



51

15,787

Restricted stock grants
510,936

1





1

Restricted stock cancellations
(66,750
)






Other comprehensive loss




(815
)

(815
)
Balance at June 30, 2016
57,543,656

$
58

$
294,810

$
(207,898
)
$
(1,640
)
$
136,338

$
221,668

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

6
Second Quarter 2016 Form 10-Q

Table of Contents

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, foundations, corporations, education institutions, and individual change agents—we connect and empower organizations to increase their impact through software, services, expertise, and data intelligence. Our portfolio is tailored to the unique needs of vertical markets, with solutions for fundraising and relationship management, digital marketing, advocacy, accounting, payments, analytics, school management, grant management, corporate social responsibility and volunteerism. Serving the industry for more than three decades, we are headquartered in Charleston, South Carolina and have operations in the United States, Australia, Canada, Ireland and the United Kingdom. As of June 30, 2016, we had approximately 35,000 active customers.
2. Summary of Significant Accounting Policies
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 ("GAAP"). The consolidated balance sheet at December 31, 2015, has been derived from the audited consolidated financial statements at that date. Operating results and cash flows for the six months ended June 30, 2016 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2016, 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, 2015, and other forms filed with the SEC from time to time.
Reclassifications

In order to provide comparability between periods presented, "interest income", "loss on sale of business", "loss on debt extinguishment and termination of derivative instruments" and "other income (expense), net" have been combined within "other expense, net" in the previously reported consolidated statements of comprehensive income to conform to presentation of the current period. See Note 7 to these consolidated financial statements for additional details.
Basis of consolidation
The consolidated financial statements include the accounts of Blackbaud, Inc. 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 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. On an ongoing basis, we reconsider and evaluate our estimates and assumptions, including those that impact revenue recognition, long-lived and intangible assets including goodwill, stock-based compensation, the provision for income taxes, deferred taxes, capitalization of software development costs and related amortization, our allowances for sales returns and doubtful accounts, deferred sales commissions and professional services costs, valuation

Second Quarter 2016 Form 10-Q
7

Table of Contents

Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


of derivative instruments, accounting for business combinations and loss contingencies. Changes in the facts or circumstances underlying these estimates could result in material changes and actual results could materially differ from these estimates.
Revenue recognition
Our revenue is primarily generated from the following sources: (i) charging for the use of our software solutions in cloud-based and hosted environments; (ii) providing software maintenance and support services; (iii) providing professional services including implementation, training, consulting, analytic, hosting and other services; (iv) providing transaction and payment processing services; and (v) selling perpetual licenses of our software solutions.
We recognize revenue when all of the following conditions are met:
Persuasive evidence of an arrangement exists;
The solutions or services have been delivered;
The fee is fixed or determinable; and
Collection of the resulting receivable is probable.
Determining whether and when these criteria have been met can require significant judgment and estimates. We deem acceptance of a contract to be evidence of an arrangement. Delivery of our services occurs when the services have been performed. Delivery of our solutions occurs when the solution is shipped or transmitted, and title and risk of loss have transferred to the customers. Our typical arrangements do not include customer acceptance provisions; however, 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 our standard payment terms. Payment terms greater than 90 days are considered to be beyond our customary payment terms. Collection is deemed 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 defer revenue recognition until collection. Revenue is recognized net of actual and estimated sales returns and allowances.
We follow guidance provided in ASC 605-45, Principal Agent Considerations, which states that determining whether a company should recognize revenue based on the gross amount billed to a customer or the net amount retained is a matter of judgment that depends on the facts and circumstances of the arrangement and that certain factors should be considered in the evaluation.
Subscriptions
We provide software solutions to customers which are available for use in cloud-based subscription arrangements without licensing perpetual rights to the software (“cloud-based solutions”). Revenue from cloud-based solutions is recognized ratably beginning on the activation date over the term of the agreement, which generally ranges from one to three years. Any revenue related to upfront activation or set-up fees is deferred and recognized ratably over the estimated period that the customer benefits from the related cloud-based solution. Direct and incremental costs related to upfront activation or set-up activities for cloud-based solutions are capitalized until the cloud-based solution is deployed and in use, and then expensed ratably over the estimated period that the customer benefits from the related cloud-based solution.
We provide hosting services to customers who have purchased perpetual rights to certain of our software solutions (“hosting services”). Revenue from hosting services, online training programs as well as subscription-based analytic services such as data enrichment and data management services, is recognized ratably beginning on the activation date over the term of the agreement, which generally ranges from one to three years. Any related set-up fees are recognized ratably over the estimated period that the customer benefits from the related hosting service. The estimated period of benefit is evaluated on an annual basis using historical customer retention information by solution or service.
For arrangements that have multiple elements and do not include software licenses, we allocate arrangement consideration at the inception of the arrangement to those elements that qualify as separate units of accounting. The arrangement consideration is allocated to the separate units of accounting based on relative selling price method in accordance with

8
Second Quarter 2016 Form 10-Q

Table of Contents

Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


the selling price hierarchy, which includes: (i) vendor specific objective evidence (“VSOE”) of fair value if available; (ii) third-party evidence (“TPE”) if VSOE is not available; and (iii) best estimate of selling price (“BESP”) if neither VSOE nor TPE is available. In general, we use VSOE to allocate the selling price to subscription and service deliverables.
We offer certain payment processing services with the assistance of third-party vendors. In general, when we are the principal in a transaction based on the predominant weighting of factors identified in ASC 605-45, we record the revenue and related costs on a gross basis. Otherwise, we net the cost of revenue associated with the service against the gross amount billed to the customer and record the net amount as revenue.
Revenue from transaction processing services is recognized when the service is provided and the amounts are determinable. Revenue directly associated with processing donations for customers are included in subscriptions revenue.
Maintenance
We recognize revenue from maintenance services ratably over the term of the arrangement, generally one year at contract inception with annual renewals thereafter. Maintenance contracts are at rates that vary according to the level of the maintenance program associated with the software solution and are generally renewable annually. Maintenance contracts may also include the right to unspecified solution upgrades on an if-and-when available basis. Certain incremental support services are sold in prepaid units of time and recognized as revenue upon their usage.
Services
We generally bill consulting, installation and implementation services based on hourly rates plus reimbursable travel-related expenses. Revenue is recognized for these services over the period the services are delivered.
We recognize analytic services revenue from donor prospect research engagements, the sale of lists of potential donors, benchmarking studies and data modeling service engagements upon delivery. In arrangements where we provide customers the right to updated information during the contract period, revenue is recognized ratably over the contract period.
We sell fixed-rate programs, which permit customers to attend unlimited training over a specified contract period, typically one year, subject to certain restrictions, and revenue in those cases is recognized ratably over the contract period. Additionally, 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 recognize the related revenue upon the customer attending and completing training.
License fees
We sell perpetual software licenses with maintenance, varying levels of professional services and, in certain instances, with hosting services. We allocate revenue to each of the elements in these arrangements using the residual method under which we first allocate revenue to the undelivered elements, typically the non-software license components, based on VSOE of fair value of the various elements. We determine VSOE of fair value of the various elements using different methods. VSOE of fair value for maintenance services associated with software licenses is based upon renewal rates stated in the arrangements with customers, which demonstrate a consistent relationship of maintenance pricing as a percentage of the contractual license fee. VSOE of fair value of professional services and other solutions and services is based on the average selling price of these same solutions and services to other customers when sold on a stand-alone basis. Any remaining revenue is allocated to the delivered elements, which is normally the software license in the arrangement. In general, revenue is recognized for software licenses upon delivery to our customers.
When a software license is sold with software customization services, generally the services are to provide the customer assistance in creating special reports and other enhancements that will improve operational efficiency and/or help to support business process improvements. These services are generally not essential to the functionality of the software and the related revenues are recognized either as the services are delivered or upon completion. However, when software customization services are considered essential to the functionality of the software, we recognize revenue for both the software license and the services using the percentage-of-completion method.

Second Quarter 2016 Form 10-Q
9

Table of Contents

Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


Deferred revenue
To the extent that our customers are billed for the above described solutions and services in advance of delivery, we record such amounts in deferred revenue. Generally, our subscription and maintenance customers are billed one year in advance.
Fair value measurements
We measure certain financial assets and liabilities at fair value on a recurring basis, including derivative instruments. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. An active market is defined as a market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis. 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.
Our financial assets and liabilities are classified in their entirety within the hierarchy based on the lowest level of input that is significant to fair value measurement. Changes to a financial asset's or liability's level within the fair value hierarchy are determined as of the end of a reporting period. All methods of assessing fair value result in a general approximation of value, and such value may never actually be realized.
Earnings per share
We compute basic earnings per share by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. 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 outstanding during the period. Diluted earnings 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.
Recently adopted accounting pronouncements

In September 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2015-16, Simplifying the Accounting for Measurement-Period Adjustments (ASU 2015-16). ASU 2015-16 requires for acquirers in business combinations to recognize adjustments to provisional amounts identified during measurement periods in the reporting periods in which adjusted amounts are determined. The update requires that acquirers record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization or other income effects, if any, resulting from changes in provisional amounts, calculated as if the accounting had been completed at acquisition date. The update also requires separate income statement presentation or note disclosure of amounts recorded in current period earnings by line item that would have been recorded in previous reporting periods if the provisional amount adjustments had been recognized at the acquisition date (requirements to retrospectively account for those adjustments have been eliminated). The guidance is effective for annual reporting periods beginning after December 15, 2015, including interim periods within that reporting period. Amendments in this update should be applied prospectively to adjustments to provisional amounts that occur after its effective date, with earlier application permitted for financial statements that have not been issued. We adopted ASU 2015-16 on January 1, 2016. See Note 3 to these consolidated financial statements for details of any immaterial measurement period adjustments.


10
Second Quarter 2016 Form 10-Q

Table of Contents

Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


In April 2015, the FASB issued ASU No. 2015-05, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40) - Customer's Accounting for Fees Paid in a Cloud Computing Arrangement (ASU 2015-05). The amendments in this update provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the update specifies that the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. The update further specifies that the customer should account for a cloud computing arrangement as a service contract if the arrangement does not include a software license. An entity can elect to adopt the amendments either (1) prospectively to all arrangements entered into or materially modified after the effective date or (2) retrospectively. We adopted ASU 2015-05 on January 1, 2016 on a prospective basis and it did not have a material impact on our consolidated financial statements.
In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest - Simplifying the Presentation of Debt Issuance Costs (ASU 2015-03). ASU 2015-03 sets forth a requirement that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs is not affected by the amendments in this update. An entity should apply the new guidance on a retrospective basis, wherein the balance sheet of each individual period presented is adjusted to reflect the period-specific effects of applying the new guidance. We adopted ASU 2015-03 on January 1, 2016 and retrospectively restated "other assets" and "debt, net of current portion", which had the effect of reducing each of those respective line items in our December 31, 2015 consolidated balance sheet by approximately $0.5 million.
Recently issued accounting pronouncements
In March 2016, the FASB issued ASU 2016-09, Compensation — Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting (ASU 2016-09). ASU 2016-09 updates the accounting for certain aspects of share-based payments to employees. Entities will be required to recognize the income tax effects of awards in the income statement when the awards vest or are settled. The guidance also updates an employers’ accounting for an employee’s use of shares to satisfy the employer’s statutory income tax withholding obligation and accounting for forfeitures. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted but all of the guidance must be adopted in the same period. We expect ASU 2016-09 will impact our consolidated balance sheets, statements of comprehensive income and cash flows, and we are currently evaluating the extent of the impact that implementation of this standard will have on adoption. We are currently considering early adopting this new guidance during 2016.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (ASU 2016-02). ASU 2016-02 will require lessees to record most leases on their balance sheets but recognize expenses in the income statement in a manner similar to current guidance. The updated guidance also eliminates certain real estate-specific provisions and changes the guidance on sale-leaseback transactions, initial direct costs and lease executory costs for all entities. For lessors, the standard modifies the classification criteria and the accounting for sales-type and direct financing leases. All entities will classify leases to determine how to recognize lease-related revenue and expense. Classification will continue to affect amounts that lessors record on the balance sheet. ASU 2016-02 is effective for annual periods beginning after December 15, 2018, and interim periods within those years. Early adoption is permitted. Upon adoption, entities will be required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply. We expect ASU 2016-02 will impact our consolidated financial statements and are currently evaluating the extent of the impact that implementation of this standard will have on adoption.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (ASU 2014-09). ASU 2014-09 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and will replace most existing revenue recognition guidance in GAAP when it becomes effective. ASU 2014-09 was originally effective for fiscal years and interim periods within those years beginning after December 15, 2016. An entity should apply ASU 2014-09 either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the ASU recognized as an adjustment to the opening balance of retained earnings at the date of initial application. In July, 2015, the FASB decided to delay the effective date of the new standard for one year. The new standard now requires application no later than annual reporting periods beginning after December 15, 2017, including interim reporting periods therein; however, public entities are permitted to elect to early adopt the new standard as of the original effective date. In March 2016, the FASB finalized amendments to the guidance in the new

Second Quarter 2016 Form 10-Q
11

Table of Contents

Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


standard to clarify whether an entity is a principal or an agent in a revenue transaction. In April 2016, the FASB finalized additional amendments to the guidance in the new standard to clarify the accounting for licenses of intellectual property and identifying performance obligations. We expect the adoption of ASU 2014-09 will impact our consolidated financial statements. We are currently evaluating implementation methods and the extent of the impact that implementation of this standard and the recently issued clarifying amendments will have upon adoption.
3. Business Combinations
2015 Acquisitions
Smart Tuition
On October 2, 2015, we completed our acquisition of all of the outstanding equity, including all voting equity interests, of Smart, LLC (“Smart Tuition”). Smart Tuition is a leading provider of payment software and services for private schools and parents. The acquisition of Smart Tuition further expanded our offerings in the K-12 technology sector. We acquired Smart Tuition for $187.3 million in cash, net of closing adjustments including an adjustment of approximately $0.5 million during the three months ended March 31, 2016. We received the proceeds from these closing adjustments during the three months ended June 30, 2016. On October 2, 2015, we drew down a $186.0 million revolving credit loan under our 2014 Credit Facility (as defined in Note 8 below) to finance the acquisition of Smart Tuition. As a result of the acquisition, Smart Tuition has become a wholly-owned subsidiary of ours. We included the operating results of Smart Tuition as well as goodwill arising from the acquisition in our consolidated financial statements within the General Markets Business Unit ("GMBU") from the date of acquisition. For the three months ended June 30, 2016, Smart Tuition's total revenue and operating income included in our consolidated financial statements was $8.2 million and $0.6 million, respectively. For the six months ended June 30, 2016, Smart Tuition's total revenue and operating income included in our consolidated financial statements was $17.4 million and $1.8 million, respectively.
The preliminary purchase price allocation is based upon a preliminary valuation of assets and liabilities and the estimates and assumptions are subject to change as we obtain additional information during the measurement period, which may be up to one year from the acquisition date. The assets and liabilities pending finalization include the valuation of acquired intangible assets, the assumed deferred revenue and deferred taxes. Differences between the preliminary and final valuation could have a material impact on our future results of operations and financial position.
The following table summarizes the preliminary allocation of the purchase price based on the estimated fair value of the assets acquired and the liabilities assumed:
(dollars in thousands)
Purchase Price Allocation

Net working capital, excluding deferred revenue
$
276

Property and equipment
2,457

Deferred revenue
(6,500
)
Deferred tax asset
2,637

Intangible assets
97,800

Goodwill
90,302

Total purchase price(1)
$
186,972

(1) The purchase price differs from the net cash outlay of $187.3 million due to certain insignificant acquisition-related expenses included therein.

The estimated fair value of accounts receivable acquired approximates the contractual value of $2.8 million. The estimated goodwill recognized is attributable primarily to the opportunities for expected synergies from combining operations and the assembled workforce of Smart Tuition, all of which was assigned to our GMBU reporting segment. Approximately $86.2 million of the goodwill arising in the acquisition is deductible for income tax purposes.
 

12
Second Quarter 2016 Form 10-Q

Table of Contents

Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


The Smart Tuition acquisition resulted in the identification of the following identifiable intangible assets:
 
Intangible
assets
acquired

Weighted
average amortization period
 
 (in thousands)

(in years)
Customer relationships
$
72,300

17
Marketing assets
1,200

3
Acquired technology
22,100

7
Non-compete agreements
2,200

5
Total intangible assets
$
97,800

14

The estimated fair values of the finite-lived intangible assets were based on variations of the income approach, which estimates fair value based on the present value of cash flows that the assets are expected to generate which included the relief-from-royalty method, incremental cash flow method including the with and without method and excess earnings method, depending on the intangible asset being valued. The method of amortization of identifiable finite-lived intangible assets is based on the expected pattern in which the estimated economic benefits of the respective assets are consumed or otherwise used up. Customer relationships and acquired technology are being amortized on an accelerated basis while marketing assets and non-compete agreements are being amortized on a straight-line basis.

The following unaudited pro forma condensed combined consolidated results of operations assume that the acquisition of Smart Tuition occurred on January 1, 2014. This unaudited pro forma financial information does not reflect any adjustments for anticipated synergies resulting from the acquisition and should not be relied upon as being indicative of the historical results that would have been attained had the transaction been consummated as of January 1, 2014, or of the results that may occur in the future. The unaudited pro forma information reflects adjustments for amortization of intangibles related to the fair value adjustments of the assets acquired, write-down of acquired deferred revenue to fair value, additional interest expense related to the financing of the transaction and the related tax effects of the adjustments.
 
Three months ended 
 June 30,

 
Six months ended 
 June 30,

(dollars in thousands, except per share amounts)
2015

 
2015

Revenue
$
164,170

 
$
319,982

Net income
$
6,084

 
$
10,523

Basic earnings per share
$
0.13

 
$
0.23

Diluted earnings per share
$
0.13

 
$
0.23


Second Quarter 2016 Form 10-Q
13

Table of Contents

Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


4. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share:
  
Three months ended 
 June 30,
 
 
Six months ended 
 June 30,
 
(dollars in thousands, except per share amounts)
2016

2015

 
2016

2015

Numerator:
 
 
 
 
 
Net income
$
7,813

$
7,042

 
$
12,808

$
11,327

Denominator:
 
 
 
 
 
Weighted average common shares
46,083,055

45,579,345

 
46,047,788

45,554,645

Add effect of dilutive securities:
 
 
 
 
 
Stock-based compensation
844,571

823,362

 
817,430

734,795

Weighted average common shares assuming dilution
46,927,626

46,402,707

 
46,865,218

46,289,440

Earnings per share:
 
 
 
 
 
Basic
$
0.17

$
0.15

 
$
0.28

$
0.25

Diluted
$
0.17

$
0.15

 
$
0.27

$
0.24


The following shares underlying stock-based awards were not included in diluted earnings per share because their inclusion would have been anti-dilutive:
  
Three months ended 
 June 30,
 
 
Six months ended 
 June 30,
 
  
2016

2015

 
2016

2015

Shares excluded from calculations of diluted earnings per share

12,705

 
44,134

10,152


14
Second Quarter 2016 Form 10-Q

Table of Contents

Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


5. Fair Value Measurements
Recurring fair value measurements
Financial assets and liabilities measured at fair value on a recurring basis consisted of the following, as of:
 
Fair value measurement using
 
 
(dollars in thousands)
Level 1

 
Level 2

 
Level 3

 
Total

Fair value as of June 30, 2016
 
 
 
 
 
 
 
Financial liabilities:
 
 
 
 
 
 
 
Derivative instruments(1)
$

 
$
1,329

 
$

 
$
1,329

Total financial liabilities
$

 
$
1,329

 
$

 
$
1,329

 
 
 
 
 
 
 
 
Fair value as of December 31, 2015
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
Derivative instruments(1)
$

 
$
406

 
$

 
$
406

Total financial assets
$

 
$
406

 
$

 
$
406

 
 
 
 
 
 
 
 
Fair value as of December 31, 2015
 
 
 
 
 
 
 
Financial liabilities:
 
 
 
 
 
 
 
Derivative instruments(1)
$

 
$
438

 
$

 
$
438

Total financial liabilities
$

 
$
438

 
$

 
$
438

(1)
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.
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 June 30, 2016 and December 31, 2015, due to the immediate or short-term maturity of these instruments.
We believe the carrying amount of our debt approximates its fair value at June 30, 2016 and December 31, 2015, 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.

Non-recurring fair value measurements

Assets and liabilities that are measured at fair value on a non-recurring basis include intangible assets and goodwill which are recognized at fair value during the period in which an acquisition is completed, 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 intangible assets acquired, were based on Level 3 unobservable inputs. In the event of an impairment, we determine the fair value of the goodwill and intangible assets 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.

There were no non-recurring fair value adjustments to intangible assets and goodwill during the six months ended June 30, 2016, except for certain insignificant business combination accounting adjustments to the initial fair value estimates of the Smart Tuition assets acquired and liabilities assumed at the acquisition date from updated information obtained during the measurement period. See Note 3 to these consolidated financial statements for additional details. The measurement period may be up to one year from the acquisition date. We record any measurement period adjustments to the fair value of assets acquired and liabilities assumed, with the corresponding offset to goodwill.

Second Quarter 2016 Form 10-Q
15

Table of Contents

Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


6. Goodwill and Other Intangible Assets
The change in goodwill for each reportable segment (as defined in Note 14 below) during the six months ended June 30, 2016, consisted of the following:
(dollars in thousands)
ECBU
GMBU
IBU
Total
Balance at December 31, 2015
$
240,494

$
190,976

$
4,979

$
436,449

Adjustments related to prior year business combinations(1)

(256
)

(256
)
Effect of foreign currency translation


(181
)
(181
)
Balance at June 30, 2016
$
240,494

$
190,720

$
4,798

$
436,012

(1)
See Note 3 to these consolidated financial statements for details of certain of the immaterial measurement period adjustments.
Amortization expense
Amortization expense related to finite-lived intangible assets acquired in business combinations is allocated to cost of revenue on the consolidated statements of comprehensive income based on the revenue stream to which the asset contributes, except for marketing assets and non-compete agreements, for which the associated amortization expense is included in operating expenses.
The following table summarizes amortization expense:
 
Three months ended 
 June 30,
 
 
Six months ended 
 June 30,
 
(dollars in thousands)
2016

2015

 
2016

2015

Included in cost of revenue:
 
 
 
 
 
Cost of subscriptions
$
7,853

$
5,767

 
$
15,664

$
11,539

Cost of maintenance
1,332

1,006

 
2,664

2,159

Cost of services
657

702

 
1,310

1,309

Cost of license fees and other
85

92

 
170

199

Total included in cost of revenue
9,927

7,567

 
19,808

15,206

Included in operating expenses
708

524

 
1,460

1,012

Total amortization of intangibles from business combinations
$
10,635

$
8,091

 
$
21,268

$
16,218


The following table outlines the estimated future amortization expense for each of the next five years for our finite-lived intangible assets as of June 30, 2016:
(dollars in thousands)
Years ending December 31,
Amortization expense

2016 - remaining
$
20,991

2017 
41,426

2018 
39,788

2019 
36,479

2020 
27,701

Total
$
166,385


16
Second Quarter 2016 Form 10-Q

Table of Contents

Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


7. Consolidated Financial Statement Details
Prepaid expenses and other assets
(dollars in thousands)
June 30,
2016

December 31,
2015

Deferred sales commissions
$
34,027

$
30,141

Prepaid software maintenance
20,670

15,308

Deferred professional services costs
2,586

3,603

Taxes, prepaid and receivable
6,398

9,121

Deferred tax asset
3,385

2,869

Prepaid royalties
1,442

1,767

Other assets
7,136

6,758

Total prepaid expenses and other assets
75,644

69,567

Less: Long-term portion
21,847

20,901

Prepaid expenses and other current assets
$
53,797

$
48,666

Accrued expenses and other liabilities
(dollars in thousands)
June 30,
2016

December 31,
2015

Accrued bonuses
$
11,979

$
24,591

Accrued commissions and salaries
8,371

8,391

Taxes payable
4,523

3,923

Deferred rent liabilities
4,108

4,070

Lease incentive obligations
4,306

4,734

Unrecognized tax benefit
3,299

3,147

Customer credit balances
4,305

3,515

Accrued vacation costs
2,256

2,446

Accrued health care costs
2,564

2,356

Other liabilities
7,130

7,911

Total accrued expenses and other liabilities
52,841

65,084

Less: Long-term portion
8,102

7,623

Accrued expenses and other current liabilities
$
44,739

$
57,461

Deferred revenue
(dollars in thousands)
June 30,
2016

December 31,
2015

Subscriptions
$
139,177

$
122,524

Maintenance
86,084

85,901

Services
29,725

28,517

License fees and other
1,675

393

Total deferred revenue
256,661

237,335

Less: Long-term portion
6,212

7,119

Deferred revenue, current portion
$
250,449

$
230,216


Second Quarter 2016 Form 10-Q
17

Table of Contents

Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


Other expense, net
  
Three months ended 
 June 30,
 
 
Six months ended 
 June 30,
 
(dollars in thousands)
2016

2015

 
2016

2015

Interest income
$
118

$
7

 
$
239

$
15

Loss on sale of business

(1,976
)
 

(1,976
)
Other (expense) income, net
(183
)
695

 
(409
)
400

Other expense, net
$
(65
)
$
(1,274
)
 
$
(170
)
$
(1,561
)
8. 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)
June 30,
2016

December 31,
2015

 
June 30,
2016

December 31,
2015

Credit facility:
 
 
 
 
 
    Revolving credit loans
$
239,900

$
242,900

 
2.19
%
2.15
%
    Term loans
165,156

167,344

 
2.53
%
2.51
%
        Total debt
405,056

410,244

 
2.33
%
2.30
%
Less: Unamortized debt discount
1,816

2,157

 
 
 
Less: Debt, current portion
4,375

4,375

 
2.14
%
2.11
%
Debt, net of current portion
$
398,865

$
403,712

 
2.33
%
2.30
%
Summary of the 2014 Credit Facility
In February 2014, we entered into a five-year $325.0 million credit facility (the “2014 Credit Facility”) and drew $175.0 million on a term loan upon closing, which was used to repay all amounts outstanding under the 2012 Credit Facility.
The 2014 Credit Facility includes the following facilities: (i) a dollar and a designated currency revolving credit facility with sublimits for letters of credit and swingline loans (the “2014 Revolving Facility”) and (ii) a term loan facility (the “2014 Term Loan”).
In connection with our entry into the 2014 Credit Facility, we paid $2.5 million in financing costs, of which $1.1 million were capitalized and, together with a portion of the unamortized deferred financing costs from prior facilities, are being amortized into interest expense over the term of the new facility using the effective interest method. As of June 30, 2016 and December 31, 2015, deferred financing costs totaling $0.7 million and $0.9 million, respectively, were included in other assets on the consolidated balance sheet.
The 2014 Credit Facility is secured by the stock and limited liability company interests of certain of our subsidiaries and is guaranteed by our material domestic subsidiaries.
Amounts borrowed under the dollar tranche revolving credit loans and term loan under the 2014 Credit Facility bear interest at a rate per annum equal to, at our option, (a) a base rate equal to the highest of (i) the prime rate, (ii) federal funds rate plus 0.50% and (iii) one month LIBOR plus 1.00% (the “Base Rate”), in addition to a margin of 0.00% to 0.50%, or (b) LIBOR rate plus a margin of 1.00% to 1.50%.
We also pay a quarterly commitment fee on the unused portion of the 2014 Revolving Facility from 0.15% to 0.225% per annum, depending on our net leverage ratio. At June 30, 2016, the commitment fee was 0.225%.

18
Second Quarter 2016 Form 10-Q

Table of Contents

Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


The 2014 Term Loan requires periodic principal payments. The balance of the 2014 Term Loan and any amounts drawn on the 2014 Revolving Facility are due upon maturity of the 2014 Credit Facility in February 2019. We evaluate the classification of our debt as current or non-current based on the required annual maturities of the 2014 Credit Facility.
The 2014 Credit Facility includes financial covenants related to the net leverage ratio and interest coverage ratio, as well as restrictions on our ability to declare and pay dividends and our ability to repurchase shares of our common stock. At June 30, 2016, we were in compliance with our debt covenants under the 2014 Credit Facility.
Financing for MicroEdge acquisition
The 2014 Credit Facility includes an option to request increases in the revolving commitments and/or request additional term loans in an aggregate principal amount of up to $200.0 million. On October 1, 2014, we exercised this option, and certain lenders agreed, to increase the revolving credit commitments by $100.0 million (the "October 2014 Additional Revolving Credit Commitments") such that for the period commencing October 1, 2014, the aggregate revolving credit commitments available were $250.0 million. The October 2014 Additional Revolving Credit Commitments have the same terms as the existing revolving credit commitments.
On October 1, 2014, we drew down a $140.0 million revolving credit loan under the 2014 Credit Facility to finance the acquisition of MicroEdge.
Financing for Smart Tuition acquisition
On July 17, 2015, we again exercised this option and certain lenders agreed to increase the revolving credit commitments by an additional $100.0 million (the "July 2015 Additional Revolving Credit Commitments") such that commencing July 17, 2015, the aggregate revolving credit commitments available were $350.0 million. The July 2015 Additional Revolving Credit Commitments have the same terms as the existing revolving credit commitments.
On October 2, 2015, we drew down a $186.0 million revolving credit loan under the 2014 Credit Facility to finance the acquisition of Smart Tuition.
As of June 30, 2016, the required annual maturities related to the 2014 Credit Facility were as follows:
Years ending December 31,
(dollars in thousands)
Annual maturities

2016 - remaining
$
2,187

2017 
4,375

2018 
4,375

2019 
394,119

2020 

Thereafter

Total required maturities
$
405,056

9. Derivative Instruments
We use derivative instruments to manage our variable interest rate risk. In March 2014, we entered into an interest rate swap agreement (the "March 2014 Swap Agreement"), which effectively converts portions of our variable rate debt under the 2014 Credit Facility to a fixed rate for the term of the swap agreement. The initial notional value of the March 2014 Swap Agreement was $125.0 million with an effective date beginning in March 2014. In March 2017, the notional value of the March 2014 Swap Agreement will decrease to $75.0 million for the remaining term through February 2018. We designated the March 2014 Swap Agreement as a cash flow hedge at the inception of the contract.

Second Quarter 2016 Form 10-Q
19

Table of Contents

Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


In October 2014, we entered into an additional interest rate swap agreement (the “October 2014 Swap Agreement”), which effectively converted portions of our variable rate debt under the 2014 Credit Facility to a fixed rate for the term of the swap agreement. The initial notional value of the October 2014 Swap Agreement was $75.0 million with an effective date beginning in October 2014. In September 2015, the notional value of the October 2014 Swap Agreement decreased to $50.0 million for the remaining term through June 2016. We designated the October 2014 Swap Agreement as a cash flow hedge at the inception of the contract.

In October 2015, we entered into an additional interest rate swap agreement (the "October 2015 Swap Agreement"), which effectively converts portions of our variable rate debt under the 2014 Credit Facility to a fixed rate for the term of the October 2015 Swap Agreement. The notional value of the October 2015 Swap Agreement was $75.0 million with an effective date beginning in October 2015 and maturing in February 2018. We designated the October 2015 Swap Agreement as a cash flow hedge at the inception of the contract.
The fair values of our derivative instruments were as follows as of:
(dollars in thousands)
Balance sheet location
June 30,
2016

December 31,
2015

Derivative instruments designated as hedging instruments:
 
 
 
Interest rate swap, long-term portion
Other assets
$

$
406

Total derivative instruments designated as hedging instruments
 
$

$
406

 

June 30,
2016

December 31,
2015

Derivative instruments designated as hedging instruments:
 
 
 
Interest rate swaps, current portion
Accrued expenses and
other current liabilities
$

$
2

Interest rate swaps, long-term portion
Other liabilities
(1,329
)
436

Total derivative instruments designated as hedging instruments
 
$
(1,329
)
$
438

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)
June 30,
2016

Three months ended 
 June 30, 2016

 
Six months ended 
 June 30, 2016

Interest rate swaps
$
(1,329
)
Interest expense
$
(302
)
 
$
(610
)
 
 
 
 
 
 
 
June 30,
2015

 
Three months ended 
 June 30, 2015

 
Six months ended 
 June 30, 2015

Interest rate swaps
$
(873
)
Interest expense
$
(374
)
 
$
(749
)
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 June 30, 2016 that is expected to be reclassified into earnings within the next twelve months is $1.0 million. There were no ineffective portions of our interest rate swap derivatives during the six months ended June 30, 2016 and 2015. See Note 13 to these consolidated financial statements for a summary of the changes in accumulated other comprehensive income (loss) by component.

20
Second Quarter 2016 Form 10-Q

Table of Contents

Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


10. Commitments and Contingencies

Historical Leases

We lease our headquarters facility under a 15-year lease agreement which was entered into in October 2008, and has two five-year renewal options. The current annual base rent of the lease is $5.1 million, payable in equal monthly installments. The base rent escalates annually at a rate equal to the change in the consumer price index, as defined in the agreement, but not to exceed 5.5% in any year.
We have a lease for office space in Austin, Texas which terminates on September 30, 2023, and has two five-year renewal options. Under the terms of the lease, we will increase our leased space by approximately 20,000 square feet on July 31, 2016. The current annual base rent of the lease is $2.3 million. The base rent escalates annually between 2% and 4% based on the terms of the agreement. The rent expense is recorded on a straight-line basis over the length of the lease term. At June 30, 2016, we had a standby letter of credit of $2.0 million for a security deposit for this lease.
We have provisions in our leases that entitle us to aggregate remaining leasehold improvement allowances of $3.6 million. These amounts are being recorded as a reduction to rent expense ratably over the terms of the leases. The reductions in rent expense related to these lease provisions during the three and six months ended June 30, 2016 and 2015, were insignificant. The leasehold improvement allowances have been included in the table of operating lease commitments below as a reduction in our lease commitments ratably over the then remaining terms of the leases. The timing of the reimbursements for the actual leasehold improvements may vary from the amounts reflected in the table below.
We have also received, and expect to receive through 2016, quarterly South Carolina state incentive payments as a result of locating our headquarters facility in Berkeley County, South Carolina. These amounts are recorded as a reduction of rent expense upon receipt and were $0.7 million and $0.6 million for the three months ended June 30, 2016 and 2015, respectively, and $1.6 million and $1.2 million for the six months ended June 30, 2016 and 2015, respectively.
Total rent expense was $3.5 million and $2.4 million for the three months ended June 30, 2016 and 2015, respectively, and $5.5 million and $4.9 million for the six months ended June 30, 2016 and 2015, respectively.

Lease for New Headquarters Facility

In May 2016, we entered into a lease agreement for a new headquarters facility to be built in Charleston, South Carolina ("the New Headquarters Facility"). The landlord is responsible for the design, development and construction of the New Headquarters Facility. Construction of the New Headquarters Facility will proceed in two phases. Phase One will include a building with approximately 172,000 rentable square feet, which is expected to be completed in the first quarter of 2018. The lease agreement also grants us a Phase Two option to request that the landlord construct and lease to us a second office building and related improvements. Total rent payments and leasehold improvement allowances for Phase One are estimated to be approximately $102.0 million and $12.9 million, respectively, over the life of the lease agreement, plus additional amounts for Phase Two, if applicable. The lease agreement is for a period of twenty years beginning on the date of substantial completion of construction by the landlord, which is estimated to be in the first quarter of 2018, and ending in the first quarter of 2038. The lease agreement provides for four renewal periods of five years each at a base rent equal to the then prevailing market rate for comparable buildings. We expect to receive quarterly South Carolina state incentive payments as a result of locating our headquarters facility in Berkeley County, South Carolina.

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Notes to consolidated financial statements (continued)
(Unaudited)


As of June 30, 2016, the future minimum lease commitments related to lease agreements, net of related lease incentives, were as follows:
Years ending December 31,
(dollars in thousands)
Operating leases(1)

2016 – remaining
$
6,872

2017 
12,085

2018 
11,369

2019 
11,792

2020 
11,073

Thereafter
97,994

Total minimum lease payments
$
151,185

(1)
Our future minimum lease commitments related to operating leases do not include payments related to Phase Two of our New Headquarters Facility, as that option had not been exercised as of June 30, 2016.
Other commitments
As discussed in Note 8 to these consolidated financial statements, the term loans under the 2014 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 2014 Credit Facility in February 2019.
We utilize third-party technology in conjunction with our solutions and services, with contractual obligations varying in length from one to four years. In certain cases, such arrangements require a minimum annual purchase commitment. As of June 30, 2016, the remaining aggregate minimum purchase commitment under these arrangements was approximately $41.9 million through 2020.
Product 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 contingencies
We are subject to legal proceedings and claims that arise in the ordinary course of business. We record an accrual for a contingency when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. As of June 30, 2016, in our opinion, there was not at least a reasonable possibility that these actions arising in the ordinary course of business will have a material adverse effect upon our consolidated financial position, results of operations or cash flows and, therefore, no material loss contingencies were recorded.

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Notes to consolidated financial statements (continued)
(Unaudited)


11. Income Taxes
Our income tax provision and effective income tax rates including the effects of period-specific events, were:
  
Three months ended 
 June 30,
 
 
Six months ended 
 June 30,
 
(dollars in thousands)
2016

2015

 
2016

2015

Income tax provision
$
3,598

$
4,272

 
$
6,262

$
6,026

Effective income tax rate
31.5
%
37.8
%
 
32.8
%
34.7
%
The decreases in our effective income tax rates during the three and six months ended June 30, 2016, when compared to the same periods in 2015, were primarily due to a loss included in the 2015 periods from the sale of our Netherlands entity for which we did not record a tax benefit and the estimated benefit to our annual 2016 effective tax rate from federal and state research tax credits that were permanently enacted into law in December 2015. The decreases in our effective tax rates during the three and six months ended June 30, 2016 were partially offset by the estimated impact to our annual 2016 effective tax rate from Section 162(m) nondeductible compensation.
In addition to the events that impact our effective income tax rate during both the three and six months ended June 30, 2016, when compared to the same periods in 2015, the decrease in our effective tax rate during the six months ended June 30, 2016 was also partially offset by a discrete tax benefit included in the 2015 period from the settlement of an IRS audit.
Our effective income tax rate may fluctuate quarterly as a result of factors, including transactions entered into, changes in the geographic distribution of our earnings or losses, our assessment of certain tax contingencies, valuation allowances, and changes in tax law in jurisdictions where we conduct business.
We have deferred tax assets for federal, state, and international net operating loss carryforwards and state tax credits. The federal and state net operating loss carryforwards are subject to various Internal Revenue Code limitations and applicable state tax laws. A portion of the foreign and state net operating loss carryforwards and a portion of state tax credits have a valuation reserve due to the uncertainty of realizing such carryforwards and credits in the future.
The total amount of unrecognized tax benefit that, if recognized, would favorably affect the effective income tax rate, was $2.4 million and $2.3 million at June 30, 2016 and December 31, 2015, respectively. We recognize accrued interest and penalties, if any, related to unrecognized tax benefits as a component of income tax expense.

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Notes to consolidated financial statements (continued)
(Unaudited)


12. 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 
 June 30,
 
 
Six months ended 
 June 30,
 
(dollars in thousands)
2016

2015

 
2016

2015

Included in cost of revenue:
 
 
 
 
 
Cost of subscriptions
$
290

$
325

 
$
571

$
468

Cost of maintenance
123

85

 
246

246

Cost of services
360

639

 
828

1,236

Total included in cost of revenue
773

1,049

 
1,645

1,950

Included in operating expenses:
 
 
 
 
 
Sales, marketing and customer success
921

804

 
1,822

1,506

Research and development
1,559

1,186

 
3,094

2,164

General and administrative
4,618

3,272

 
9,226

5,793

Total included in operating expenses
7,098

5,262

 
14,142

9,463

Total stock-based compensation expense
$
7,871

$
6,311

 
$
15,787

$
11,413

13. Stockholders' Equity
Dividends
Our Board of Directors has adopted a dividend policy, which provides for the distribution to stockholders of a portion of cash generated by us that is in excess of operational needs and capital expenditures. The 2014 Credit Facility limits the amount of dividends payable and certain state laws restrict the amount of dividends distributed.
In February 2016, our Board of Directors approved an annual dividend rate of $0.48 per share to be made in quarterly payments. Dividend payments are not guaranteed and our Board of Directors may decide, in its absolute discretion, at any time and for any reason, not to declare and pay further dividends. The following table provides information with respect to quarterly dividends of $0.12 per share paid on common stock during the six months ended June 30, 2016.
Declaration Date
Dividend
per Share

Record Date
 
Payable Date
February 9, 2016
$
0.12

February 26
 
March 15
April 27, 2016
$
0.12

May 27
 
June 15
On August 1, 2016, our Board of Directors declared a third quarter dividend of $0.12 per share payable on September 15, 2016 to stockholders of record on August 26, 2016.

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Notes to consolidated financial statements (continued)
(Unaudited)


Changes in accumulated other comprehensive loss by component
The changes in accumulated other comprehensive loss by component, consisted of the following:
 
Three months ended 
 June 30,
 
 
Six months ended 
 June 30,
 
(dollars in thousands)
2016

2015

 
2016

2015

Accumulated other comprehensive loss, beginning of period
$
(1,091
)
$
(1,827
)
 
$
(825
)
$
(1,032
)
By component:
 
 
 
 
 
Gains and losses on cash flow hedges:
 
 
 
 
 
Accumulated other comprehensive loss balance, beginning of period
$
(688
)
$
(633
)
 
$
(19
)
$
(164
)
Other comprehensive loss before reclassifications, net of tax effects of $195, $83, $750 and $522
(301
)
(133
)
 
(1,157
)
(831
)
Amounts reclassified from accumulated other comprehensive loss to interest expense
302

374

 
610

749

Tax benefit included in provision for income taxes
(119
)
(144
)
 
(240
)
(290
)
Total amounts reclassified from accumulated other comprehensive loss
183

230

 
370

459

Net current-period other comprehensive (loss) income
(118
)
97

 
(787
)
(372
)
Accumulated other comprehensive loss balance, end of period
$
(806
)
$
(536
)
 
$
(806
)
$
(536
)
Foreign currency translation adjustment:
 
 
 
 
 
Accumulated other comprehensive loss balance, beginning of period
$
(403
)
$
(1,194
)
 
$
(806
)
$
(868
)
Translation adjustments
(431
)
(196
)
 
(28
)
(522
)
Accumulated other comprehensive loss balance, end of period
(834
)
(1,390
)
 
(834
)
(1,390
)
Accumulated other comprehensive loss, end of period
$
(1,640
)
$
(1,926
)
 
$
(1,640
)
$
(1,926
)
14. Segment Information
As of June 30, 2016, our reportable segments were the General Markets Business Unit ("GMBU"), the Enterprise Customer Business Unit ("ECBU"), and the International Business Unit ("IBU"). Following is a description of each reportable segment:
The GMBU is focused on marketing, sales, delivery and support to all emerging and mid-sized prospects and customers in North America;
The ECBU is focused on marketing, sales, delivery and support to all large and/or strategic prospects and customers in North America; and
The IBU is focused on marketing, sales, delivery and support to all prospects and customers outside of North America.
Our CODM is our chief executive officer ("CEO"). The CEO reviews financial information presented on an operating segment basis for the purposes of making certain operating decisions and assessing financial performance. The CEO uses internal financial reports that provide segment revenues and operating income, excluding stock-based compensation expense, amortization expense, depreciation expense, research and development expense and certain corporate sales, marketing, general and administrative expenses. Currently, the CEO believes that the exclusion of these costs allows for a better understanding of the operating performance of the operating units and management of other operating expenses and cash needs. The CEO does not review any segment balance sheet information.

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Notes to consolidated financial statements (continued)
(Unaudited)


Summarized reportable segment financial results, were as follows:
 
Three months ended 
 June 30,
 
 
Six months ended 
 June 30,
 
(dollars in thousands)
2016

2015

 
2016

2015

Revenue by segment:
 
 
 
 
 
GMBU
93,970

76,138

 
$
181,922

$
146,067

ECBU
75,037

69,385

 
146,536

136,299

IBU
11,138

10,687

 
20,896

20,814

Other(1)
46

49

 
93

72

Total revenue
$
180,191

$
156,259

 
$
349,447

$
303,252

Segment operating income(2):
 
 
 
 
 
GMBU
45,262

39,338

 
$
87,873

$
74,001

ECBU
38,721

33,750

 
74,487

65,954

IBU
1,065

2,091

 
2,061

3,392

Other(1)
18

255

 
48

(57
)
 
85,066

75,434

 
164,469

143,290

Less:
 
 
 
 
 
Corporate unallocated costs(3)
(52,363
)
(46,571
)
 
(102,778
)
(93,186
)
Stock-based compensation costs
(7,871
)
(6,311
)
 
(15,787
)
(11,413
)
Amortization expense
(10,635
)
(8,091
)
 
(21,268
)
(16,218
)
Interest expense
(2,721
)
(1,873
)
 
(5,396
)
(3,559
)
Other expense, net
(65
)
(1,274
)
 
(170
)
(1,561
)
Income before provision for income taxes
$
11,411

$
11,314

 
$
19,070

$
17,353

(1)
Other includes revenue and the related costs from the sale of solutions and services not directly attributable to a reportable segment.
(2)
Segment operating income includes direct, controllable costs related to the sale of solutions and services by the reportable segment.
(3)
Corporate unallocated costs include research and development, depreciation expense, and certain corporate sales, marketing, general and administrative expenses.
15. Subsequent Events
On July 12, 2016, we acquired all of the outstanding equity, including all voting equity interests of Good+Geek, Inc., a Delaware corporation doing business as "Attentive.ly." Attentive.ly provides social media capabilities allowing organizations to conduct social listening, identify key influencers and drive engagement through its cloud solution. The acquisition accelerates our ability to deliver these capabilities to our customers. The results of operations of the acquired company will be included in our consolidated financial statements from the date of acquisition. Due to the timing of the transaction, the initial accounting for this acquisition, including the measurement of assets acquired, liabilities assumed and goodwill, is not complete and is pending detailed analyses of the facts and circumstances that existed as of the July 12, 2016 acquisition date. We do not expect this business combination to have a material effect on our consolidated financial position, results of operations or cash flows.

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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, foundations, corporations, education institutions, and individual change agents—we connect and empower organizations to increase their impact through software, services, expertise, and data intelligence. Our portfolio is tailored to the unique needs of vertical markets, with solutions for fundraising and relationship management, digital marketing, advocacy, accounting, payments, analytics, school management, grant management, corporate social responsibility and volunteerism. Serving the industry for more than three decades, we are headquartered in Charleston, South Carolina and have operations in the United States, Australia, Canada, Ireland and the United Kingdom. As of June 30, 2016, we had approximately 35,000 active customers.
Our revenue is primarily generated from the following sources: (i) charging for the use of our software solutions in cloud-based and hosted environments; (ii) providing software maintenance and support services; (iii) providing professional services including implementation, training, consulting, analytic, hosting and other services; (iv) providing transaction and payment processing services; and (v) selling perpetual licenses of our software solutions. We have experienced growth in our payment processing services from the continued shift to online giving, further integration of these services to our existing solution portfolio and the sale of these services to new and existing customers.
Our long-term goals include accelerating organic revenue growth, expanding our operating margins and increasing our operating cash flow. During the second quarter of 2016, we continued to execute on the following five growth strategies targeted to achieve those goals and to drive an extended period of quality enhancement, solution and service innovation, and increasing operating efficiency and financial performance:
1.
Integrated and Open Solutions in the Cloud
We continue to transition our business to predominantly serve customers through a subscription-based cloud delivery model, enabling lower cost of entry, greater scalability and lower total cost of ownership to our customers. There is a concerted effort underway to optimize our portfolio of solutions and integrate powerful capabilities — such as built in data, analytics, payment processing and tailored user-specific experiences — to bring even greater value and performance to our customers.

During the second quarter of 2016, we further expanded certain of our pre-integrated services through the general release of SKY Reporting™, beginning with Raiser's Edge NXT. SKY Reporting provides new business intelligence and reporting tools aimed at seamlessly delivering valuable insights and productivity enhancing capabilities to customers. We also launched a Partner Beta Program for SKY API, a key component of Blackbaud SKY™, which is our new, innovative cloud technology architecture for the global philanthropic community that now powers six of our next generation solutions. SKY API will allow customers, partners, and application developers to extend functionality and integrate with our solutions. On July 12, 2016, we acquired Attentive.ly, a cloud software provider that provides social media capabilities allowing organizations to conduct social listening, identify key influencers and drive engagement through its cloud solution. The acquisition accelerates our ability to deliver these capabilities to our customers by integrating Attentive.ly technology into Blackbaud SKY.


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2.
Drive Sales Effectiveness
We are making investments to increase the effectiveness of our sales organization, with a focus on enabling our expanding sales teams with the talent, processes, and tools to accelerate our revenue growth and improve effectiveness. Our customer success program separates account management from the sales organization, and is intended to drive customer loyalty and retention. In the first quarter of 2016, we launched a value added reseller ("VAR") program. During the second quarter of 2016, we continued to make investments in our sales, marketing and customer success organizations and improved our market coverage by deploying these resources into key markets like Toronto, where we recently opened a new office.
3.
Expand TAM into Near Adjacencies with Acquisitions;
We will continue to evaluate compelling opportunities to expand our product portfolio and acquire companies, technologies and/or services. We will be guided by our acquisition criteria for considering attractive assets, which expand our total addressable market ("TAM"), provide entry into new and near adjacencies, accelerate our shift to the cloud, accelerate revenue growth, are accretive to margins and present synergistic opportunities.
4.
Streamline Operations
We have largely completed the installations of best-in-breed back-office solutions to standardize operations utilizing scalable tools and systems. Our focus is now shifting towards optimizing those systems, as well as operational excellence and quality initiatives focused on streamlining processes to gain efficiency and scalability.
5.
Execute our 3-Year Margin Improvement Plan
In 2014, we implemented a 3-year operating margin improvement plan designed to increase our operating effectiveness and efficiency and improve non-GAAP operating margins 300 to 600 basis points on a constant currency basis as measured against our 2014 baseline of 17.5%, by the time we exit 2017.
We plan to continue making investments in our solution portfolio, sales, and customer success organization to ensure we are well positioned to benefit from shifts in the market, including demand for our cloud-based subscription offerings, which we expect will drive higher long-term revenue growth. We also plan to continue making investments in our sales and marketing organization and the infrastructure that supports our cloud-based subscription offerings and certain solution development initiatives, including further expansion of our payment processing and analytics services. As we execute on our five key growth initiatives to accelerate organic revenue growth and strengthen our market leadership position, we also plan to focus on achieving scalability of our operations, and attaining our targeted level of profitability.
We completed our acquisition of Smart Tuition in October 2015. We have included the results of operations of Smart Tuition in our consolidated results of operations from the date of acquisition, which impacts the comparability of our results of operations when comparing the three and six months ended June 30, 2016 to the same periods in 2015. We have noted in the discussion below, to the extent meaningful, the impact on the comparability of our consolidated results of operations to prior year results due to the inclusion of Smart Tuition.
Total revenue
 
 
 
 
 
 
 
 
Three months ended 
 June 30,
 
 
Six months ended 
 June 30,
 
(dollars in millions)
2016(1)

2015

Change

 
2016(1)

2015

Change

Total revenue
$
180.2

$
156.3

15.3
%
 
$
349.4

$
303.3

15.2
%
(1)
Included in total revenue for the three and six months ended June 30, 2016 was $8.2 million and $17.4 million attributable to the inclusion of Smart Tuition.
Excluding the impact of Smart Tuition as discussed above, total revenue increased by $15.7 million and $28.7 million, respectively, during the three and six months ended June 30, 2016 when compared to the same periods in 2015. The increases in revenue were primarily driven by growth in subscriptions revenue as our business model continues to shift towards providing predominantly cloud-based subscription solutions. Subscriptions revenue also grew as a result of increases in the number of customers and the volume of transactions for which we process payments. Services revenue contributed modestly to the increases in total revenue during the three and six months ended June 30, 2016, when compared to the same periods in 2015, primarily due to increases in consulting and training revenue. Maintenance revenue as well as license fees and other revenue declined for the three and six months ended June 30, 2016 from the continued migration of our business model toward subscription-based solutions, including our NXT solutions. In the near-term, the transition to subscription-based solutions negatively impacts total revenue growth, as time-based revenue from subscription arrangements is deferred and recognized ratably over the subscription period, whereas on-premises license revenue from

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arrangements that include perpetual licenses is recognized up-front. In addition, the fluctuation in foreign currency exchange rates, primarily those between the U.S. dollar and Canadian dollar, negatively impacted our total revenue during the three and six months ended June 30, 2016 by $0.9 million and $2.4 million, respectively. Further explanation of this impact is included below under the caption "Foreign Currency Exchange Rates".
Income from operations
 
 
 
 
 
 
 
 
Three months ended 
 June 30,
 
 
Six months ended 
 June 30,
 
(dollars in millions)
2016(1)

2015

Change

 
2016(1)

2015

Change

Income from operations
$
14.2

$
14.5

(2.1
)%
 
$
24.6

$
22.5

9.3
%
(1)
Included in income from operations for the three and six months ended June 30, 2016 was $0.6 million and $1.8 million attributable to the inclusion of Smart Tuition.
Excluding the impact of Smart Tuition as discussed above, income from operations decreased $0.9 million during the three months ended June 30, 2016 and remained relatively unchanged during the six months ended June 30, 2016 when compared to the same periods in 2015. Increases from growth in subscriptions and services revenue as discussed above, improvements in the utilization of consulting services personnel and a reduction in non-billable implementation service hours were offset by increases in stock-based compensation expense of $1.6 million and $4.4 million, respectively, amortization of intangible assets from business combinations of $2.5 million and $5.1 million, respectively, and investments we are making in our sales organization and customer success program. In addition, the fluctuation in foreign currency exchange rates, primarily those between the U.S. dollar and Canadian dollar, negatively impacted our income from operations during the three and six months ended June 30, 2016 by $0.3 million and $1.1 million, respectively. Further explanation of this impact is included below under the caption "Foreign Currency Exchange Rates".
Customer retention
Our subscription contracts are typically for a term of three years at contract inception with one year renewals thereafter. Over time, we anticipate a decrease in maintenance contract renewals as we transition our solution portfolio and maintenance customers from a perpetual license-based model to a cloud-based subscription delivery model. We also anticipate an increase in subscription contract renewals as we continue focusing on innovation, quality and the integration of our subscription 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 subscription and maintenance customer contracts provides an accurate representation of our customers' overall behavior. For the three months ended June 30, 2016, approximately 93% of our customers with recurring subscription or maintenance contracts were retained when compared to the same period in 2015.
Balance sheet and cash flow
At June 30, 2016, our cash and cash equivalents were $15.3 million and outstanding borrowings under the 2014 Credit Facility were $405.1 million. During the six months ended June 30, 2016, we generated $38.0 million in cash flow from operations, decreased our net borrowings by $5.2 million, returned $11.4 million to stockholders by way of dividends and had cash outlays of $24.7 million for purchases of property and equipment and capitalized software development costs.

Lease for New Headquarters Facility
In May 2016, we entered into a lease agreement for a New Headquarters Facility to be built in Charleston, South Carolina. For a detailed discussion of the New Headquarters Facility, see Note 10 of our consolidated financial statements in this report.

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Results of Operations
Comparison of the three and six months ended June 30, 2016 and 2015
We acquired Smart Tuition on October 2, 2015. We have included the results of operations of Smart Tuition in our consolidated results of operations from the date of acquisition, which impacts the comparability of our results of operations when comparing the three and six months ended June 30, 2016 and 2015. We have noted in the discussion below, to the extent meaningful and quantifiable, the impact on the comparability of our consolidated results of operations to prior year results due to the inclusion of Smart Tuition.
For the three and six months ended June 30, 2016, Smart Tuition's total revenue was $8.2 million and $17.4 million, respectively, and its income from operations was $0.6 million and $1.8 million, respectively. See Note 3 to our consolidated financial statements in this report for a summary of this acquisition.
Revenue by segment
 
 
 
 
 
 
 
Three months ended 
 June 30,
 
 
Six months ended 
 June 30,
 
(dollars in millions)
2016(1)

2015

Change

 
2016(1)

2015

Change

GMBU
$
94.0

$
76.1

23.5
%
 
$
181.9

$
146.1

24.5
%
ECBU
75.0

69.4

8.1
%
 
146.5

136.3

7.5
%
IBU
11.1

10.7

3.7
%
 
20.9

20.8

0.5
%
Total revenue(2)
$
180.2

$
156.3

15.3
%
 
$
349.4

$
303.3

15.2
%
(1)
Included in GMBU revenue and total revenue for the three and six months ended June 30, 2016 was $8.2 million and $17.4 million, respectively, attributable to the inclusion of Smart Tuition.
(2)
The individual amounts for each year may not sum to total revenue due to rounding.
GMBU
 
 
 
 
 
 
 
Three months ended 
 June 30,
 
 
Six months ended 
 June 30,
 
(dollars in millions)
2016(1)

2015

Change

 
2016(1)

2015

Change

GMBU revenue
$
94.0

$
76.1

23.5
%
 
$
181.9

$
146.1

24.5
%
% of total revenue
52.2
%
48.7
%
 
 
52.1
%
48.2
%
 
(1)
Included in GMBU revenue for the three and six months ended June 30, 2016 was $8.2 million and $17.4 million, respectively, attributable to the inclusion of Smart Tuition.

Excluding the impact of Smart Tuition as discussed above, GMBU revenue increased by $9.7 million and $18.4 million during the three and six months ended June 30, 2016, respectively, when compared to the same periods in 2015. The increases in GMBU revenue were primarily attributable to growth in subscriptions revenue and, to a lesser extent, services revenue. The growth in subscriptions revenue was primarily due to increases in demand across our portfolio of cloud-based solutions. GMBU subscriptions revenue also benefited from increases in the number of customers and the volume of transactions for which we process payments. GMBU services revenue increased during the three and six months ended June 30, 2016 when compared to the same periods in 2015 due to increases in consulting and training services related to our cloud-based solutions. The growth in subscriptions and services revenue was partially offset by declines in maintenance revenue and license fee and other revenue from the continued migration of our business to subscription-based solutions.

30
Second Quarter 2016 Form 10-Q

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