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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 September 30, 2018
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                     to                     .
Commission file number: 000-50600
 
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Blackbaud, Inc.
(Exact name of registrant as specified in its charter)
 
 
Delaware
11-2617163
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
65 Fairchild Street
Charleston, South Carolina 29492
(Address of principal executive offices, including zip code)
(843) 216-6200
(Registrant’s telephone number, including area code)
 
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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer    þ
Accelerated filer   
¨
Non-accelerated filer      ¨ (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES ¨ NO  þ
The number of shares of the registrant’s Common Stock outstanding as of October 24, 2018 was 48,569,024.






TABLE OF CONTENTS


Third Quarter 2018 Form 10-Q
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1

Blackbaud, Inc.

 
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, including the documents incorporated herein by reference, contains forward-looking statements that anticipate results based on our estimates, assumptions and plans that are subject to uncertainty. These "forward-looking statements" are made subject to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements consist of, among other things, 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, 2017 and in our other SEC filings. Forward-looking statements represent our management's beliefs and assumptions only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to update or revise any forward-looking statements, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statement, whether as a result of new information, future events or otherwise.

2
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Third Quarter 2018 Form 10-Q


 
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Blackbaud, Inc.
Consolidated balance sheets
(Unaudited)
(dollars in thousands)
September 30,
2018

December 31,
2017

Assets
 
 
Current assets:
 
 
Cash and cash equivalents
$
25,352

$
29,830

Restricted cash due to customers
179,729

610,344

Accounts receivable, net of allowance of $4,518 and $5,141 at September 30, 2018 and December 31, 2017, respectively
95,858

95,679

Customer funds receivable
5,501

1,536

Prepaid expenses and other current assets
68,842

61,978

Total current assets
375,282

799,367

Property and equipment, net
42,901

42,243

Software development costs, net
68,289

54,098

Goodwill
547,338

530,249

Intangible assets, net
305,394

314,651

Other assets
65,512

57,238

Total assets
$
1,404,716

$
1,797,846

Liabilities and stockholders’ equity
 
 
Current liabilities:
 
 
Trade accounts payable
$
25,453

$
24,693

Accrued expenses and other current liabilities
44,391

54,399

Due to customers
185,230

611,880

Debt, current portion
8,576

8,576

Deferred revenue, current portion
302,840

275,063

Total current liabilities
566,490

974,611

Debt, net of current portion
416,680

429,648

Deferred tax liability
47,405

48,023

Deferred revenue, net of current portion
3,429

3,643

Other liabilities
7,027

5,632

Total liabilities
1,041,031

1,461,557

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, 59,323,548 and 58,551,761 shares issued at September 30, 2018 and December 31, 2017, respectively
59

59

Additional paid-in capital
386,657

351,042

Treasury stock, at cost; 10,756,662 and 10,475,794 shares at September 30, 2018 and December 31, 2017, respectively
(266,597
)
(239,199
)
Accumulated other comprehensive income (loss)
602

(642
)
Retained earnings
242,964

225,029

Total stockholders’ equity
363,685

336,289

Total liabilities and stockholders’ equity
$
1,404,716

$
1,797,846

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

Third Quarter 2018 Form 10-Q
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3



Blackbaud, Inc.
Consolidated statements of comprehensive income
(Unaudited)
(dollars in thousands, except per share amounts)
Three months ended 
 September 30,
 
 
Nine months ended 
 September 30,
 
2018

2017

 
2018

2017

Revenue
 
 
 
 
 
Recurring
$
188,656

$
167,506

 
$
562,251

$
493,942

One-time services and other
20,876

26,918

 
65,137

77,143

Total revenue
209,532

194,424

 
627,388

571,085

Cost of revenue
 
 
 
 
 
Cost of recurring
76,535

66,747

 
221,964

196,800

Cost of one-time services and other
18,702

20,258

 
56,482

62,682

Total cost of revenue
95,237

87,005

 
278,446

259,482

Gross profit
114,295

107,419

 
348,942

311,603

Operating expenses
 
 
 
 
 
Sales, marketing and customer success
49,077

42,646

 
143,047

126,223

Research and development
24,218

22,071

 
75,473

67,647

General and administrative
24,894

23,545

 
78,392

67,350

Amortization
1,237

734

 
3,707

2,164

Restructuring
(914
)
—

 
3,585

—

Total operating expenses
98,512

88,996

 
304,204

263,384

Income from operations
15,783

18,423

 
44,738

48,219

Interest expense
(4,140
)
(3,092
)
 
(11,960
)
(8,685
)
Other (expense) income, net
(147
)
468

 
359

1,581

Income before provision for income taxes
11,496

15,799

 
33,137

41,115

Income tax provision (benefit)
332

2,975

 
(2,370
)
4,120

Net income
$
11,164

$
12,824

 
$
35,507

$
36,995

Earnings per share
 
 
 
 
 
Basic
$
0.24

$
0.27

 
$
0.75

$
0.79

Diluted
$
0.23

$
0.27

 
$
0.74

$
0.78

Common shares and equivalents outstanding
 
 
 
 
 
Basic weighted average shares
47,279,591

46,711,709

 
47,174,903

46,627,213

Diluted weighted average shares
48,160,146

47,846,997

 
48,074,698

47,679,103

Dividends per share
$
0.12

$
0.12

 
$
0.36

$
0.36

Other comprehensive income (loss)
 
 
 
 
 
Foreign currency translation adjustment
1,047

(108
)
 
(1,333
)
(305
)
Unrealized gain (loss) on derivative instruments, net of tax
566

(267
)
 
2,410

(89
)
Total other comprehensive income (loss)
1,613

(375
)
 
1,077

(394
)
Comprehensive income
$
12,777

$
12,449

 
$
36,584

$
36,601

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

4
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Third Quarter 2018 Form 10-Q

Blackbaud, Inc.
Consolidated statements of cash flows
(Unaudited)
 
Nine months ended 
 September 30,
 
(dollars in thousands)
2018

2017

Cash flows from operating activities
 
 
Net income
$
35,507

$
36,995

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Depreciation and amortization
59,993

54,765

Provision for doubtful accounts and sales returns
4,760

7,246

Stock-based compensation expense
35,683

31,055

Deferred taxes
1,430

(568
)
Amortization of deferred financing costs and discount
564

650

Other non-cash adjustments
(2,085
)
572

Changes in operating assets and liabilities, net of acquisition and disposal of businesses:
 
 
Accounts receivable
(4,480
)
(17,097
)
Prepaid expenses and other assets
(12,372
)
(2,524
)
Trade accounts payable
(134
)
(2,891
)
Accrued expenses and other liabilities
(6,923
)
(9,522
)
Deferred revenue
25,888

24,704

Net cash provided by operating activities
137,831

123,385

Cash flows from investing activities
 
 
Purchase of property and equipment
(12,910
)
(8,417
)
Capitalized software development costs
(26,629
)
(20,605
)
Purchase of net assets of acquired companies, net of cash and restricted cash acquired
(45,315
)
(49,729
)
Purchase of derivative instruments
—

(516
)
Proceeds from settlement of derivative instruments
—

1,030

Net cash used in investing activities
(84,854
)
(78,237
)
Cash flows from financing activities
 
 
Proceeds from issuance of debt
219,900

588,300

Payments on debt
(233,225
)
(594,144
)
Debt issuance costs
—

(3,085
)
Employee taxes paid for withheld shares upon equity award settlement
(27,398
)
(19,092
)
Proceeds from exercise of stock options
11

14

Change in due to customers
(425,218
)
(214,244
)
Change in customer funds receivable
(4,371
)
—

Dividend payments to stockholders
(17,484
)
(17,299
)
Net cash used in financing activities
(487,785
)
(259,550
)
Effect of exchange rate on cash, cash equivalents, and restricted cash
(285
)
(126
)
Net decrease in cash, cash equivalents, and restricted cash
(435,093
)
(214,528
)
Cash, cash equivalents, and restricted cash, beginning of period
640,174

370,673

Cash, cash equivalents, and restricted cash, end of period
$
205,081

$
156,145

The following table provides a reconciliation of cash and cash equivalents and restricted cash reported within the condensed consolidated balance sheets that sum to the total of the same such amounts shown above in the consolidated statements of cash flows:
(dollars in thousands)
September 30,
2018

December 31,
2017

Cash and cash equivalents
$
25,352

$
29,830

Restricted cash due to customers
179,729

610,344

Total cash, cash equivalents and restricted cash in the statement of cash flows
$
205,081

$
640,174

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


Third Quarter 2018 Form 10-Q
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Blackbaud, Inc.
Consolidated statement of stockholders' equity
(Unaudited)
(dollars in thousands)
Common stock
 
Additional
paid-in
capital

Treasury
stock

Accumulated
other
comprehensive
Income (loss)

Retained
earnings

Total stockholders' equity

Shares

Amount

Balance at December 31, 2017
58,551,761

$
59

$
351,042

$
(239,199
)
$
(642
)
$
225,029

$
336,289

Net income
—

—

—

—

—

35,507

35,507

Payment of dividends
—

—

—

—

—

(17,484
)
(17,484
)
Exercise of stock options and stock appreciation rights and vesting of restricted stock units
347,401

—

11

—

—

—

11

Employee taxes paid for 280,868 withheld shares upon equity award settlement
—

—

—

(27,398
)
—

—

(27,398
)
Stock-based compensation
—

—

35,604

—

—

79

35,683

Restricted stock grants
532,651

—

—

—

—

—

—

Restricted stock cancellations
(108,265
)
—

—

—

—

—

—

Other comprehensive income
—

—

—

—

1,077

—

1,077

Reclassification upon early adoption of ASU 2018-02
—

—

—

—

167

(167
)
—

Balance at September 30, 2018
59,323,548

$
59

$
386,657

$
(266,597
)
$
602

$
242,964

$
363,685

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

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Third Quarter 2018 Form 10-Q

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


 
1. Organization
We are the world’s leading cloud software company powering social good. Serving the entire social good community—nonprofits, foundations, companies, education institutions, healthcare organizations and individual change agents—we connect and empower organizations to increase their impact through cloud software, services, expertise and data intelligence. Our portfolio is tailored to the unique needs of vertical markets, with solutions for fundraising and CRM, marketing, advocacy, peer-to-peer fundraising, corporate social responsibility, school management, ticketing, grantmaking, financial management, payment processing and analytics. Serving the industry for more than three decades, we are headquartered in Charleston, South Carolina and have operations in the United States, Australia, Canada, Costa Rica and the United Kingdom. As of September 30, 2018, we had over 40,000 customers.
2. Basis of Presentation
Unaudited interim consolidated financial statements
The accompanying interim consolidated financial statements have been prepared pursuant to the rules and regulations of the United States Securities and Exchange Commission ("SEC") for interim financial reporting. These consolidated statements are unaudited and, in the opinion of management, include all adjustments (consisting of normal recurring adjustments and accruals) necessary to state fairly the consolidated balance sheets, consolidated statements of comprehensive income, consolidated statements of cash flows and consolidated statement 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, 2017, has been derived from the audited consolidated financial statements at that date. Operating results and cash flows for the nine months ended September 30, 2018 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2018, 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, 2017, and other forms filed with the SEC from time to time.
Reclassifications
Our revenue from "subscriptions" and "maintenance" and a portion of our "services and other" revenue have been combined within "recurring" revenue beginning in 2018. In order to provide comparability between periods presented, those amounts of revenue have been combined within "recurring" revenue in the previously reported consolidated statements of comprehensive income to conform to presentation of the current period. Similarly, "cost of subscriptions" and "cost of maintenance" and a portion of "cost of services and other" have been combined within "cost of recurring" in the previously reported consolidated statements of comprehensive income to conform to presentation of the current period. "Services and other" revenue has been renamed as "one-time services and other" and consists of revenue that did not meet the description of "recurring" revenue in the consolidated statements of comprehensive income. "Cost of services and other" has been renamed as "cost of one-time services and other" and consists of costs that did not meet the description of those related to "recurring" revenue in the consolidated statements of comprehensive income.
Basis of consolidation
The consolidated financial statements include the accounts of Blackbaud, Inc. and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

Third Quarter 2018 Form 10-Q
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Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


Reportable segment
We report our operating results and financial information in one operating and reportable segment. Our chief operating decision maker uses consolidated financial information to make operating decisions, assess financial performance and allocate resources. Our chief operating decision maker is our chief executive officer ("CEO").
Recently adopted accounting pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09"), which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. ASU 2014-09 replaces most previous revenue recognition guidance in GAAP and requires the recognition of revenue when promised goods or services are transferred to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard also provides guidance on the recognition of costs related to obtaining and fulfilling customer contracts.
We adopted ASU 2014-09 as of January 1, 2018 utilizing the full retrospective method of transition, which requires that the standard be applied to all periods presented. The impact of adopting ASU 2014-09 on our total revenues for 2017 and 2016 was not material. The primary impacts of adopting ASU 2014-09 relate to the deferral of incremental commission and other costs of obtaining contracts with customers and the increase to the amortization period for those costs. Previously, we deferred only direct and incremental commission costs to obtain a contract and amortized those costs over the contract term, generally three years, as the revenue was recognized. Under the new standard, we defer all incremental commission and related fringe benefit costs to obtain a contract and amortize these costs in a manner that aligns with the expected period of benefit. We utilized the 'portfolio approach' practical expedient in ASC 606-10-10-4, which allows entities to apply the guidance to a portfolio of contracts with similar characteristics because the effects on the financial statements of this approach would not differ materially from applying the guidance to individual contracts. Using the 'portfolio approach' and taking into consideration our customer contracts, our technology and other factors, we determined the expected period of benefit to be five years. We do not generally pay commissions for contract renewals.
Select adjusted unaudited financial statement information, which reflects our adoption of ASU 2014-09 is set forth below.
Consolidated balance sheets:
 
 
 
 
As of December 31, 2017
(dollars in thousands)
As Reported
Adjustments
As Adjusted
Accounts receivable, net of allowance
$
96,293

$
(614
)
$
95,679

Prepaid expenses and other current assets
$
56,099

$
5,879

$
61,978

Other assets
$
24,083

$
33,155

$
57,238

Deferred revenue, current portion
$
276,456

$
(1,393
)
$
275,063

Deferred tax liability
$
37,597

$
10,426

$
48,023

Retained earnings
$
195,649

$
29,380

$
225,029



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Third Quarter 2018 Form 10-Q

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


Consolidated statements of comprehensive income:
 
 
 
 
 
 
 
 
Three months ended September 30, 2017
 
Nine months ended September 30, 2017
(dollars in thousands, except per share amounts)
As Reported(1)
Adjustments
As Adjusted
 
As Reported(1)
Adjustments
As Adjusted
Revenue
 
 
 
 
 
 
 
Recurring
$
158,978

$
8,528

$
167,506

 
$
469,107

$
24,835

$
493,942

One-time services and other
36,535

(9,617
)
26,918

 
102,222

(25,079
)
77,143

Total revenue
$
195,513

$
(1,089
)
$
194,424

 
$
571,329

$
(244
)
$
571,085

Cost of Revenue
 
 
 
 
 
 
 
Recurring
$
63,743

$
3,004

$
66,747

 
$
187,887

$
8,913

$
196,800

One-time services and other
23,262

(3,004
)
20,258

 
71,595

(8,913
)
62,682

Total cost of revenue
$
87,005

$
—

$
87,005

 
$
259,482

$
—

$
259,482

Operating expenses
 
 
 
 
 
 
 
Sales, marketing and customer success
$
44,193

$
(1,547
)
$
42,646

 
$
129,394

$
(3,171
)
$
126,223

Net income
$
12,548

$
276

$
12,824

 
$
35,224

$
1,771

$
36,995

Basic earnings per share
$
0.27

$
—

$
0.27

 
$
0.76

$
0.03

$
0.79

Diluted earnings per share
$
0.26

$
0.01

$
0.27

 
$
0.74

$
0.04

$
0.78


(1)
See the discussion of our reclassifications of previously reported revenue and costs of revenue above.

Our adoption of ASU 2014-09 had no impact on our net cash provided by or used in operating, investing or financing activities for any of the periods reported.
Except for the accounting policies for revenue recognition and deferred commissions (herein referred to as "costs of obtaining contracts") that were updated as a result of adopting ASU 2014-09, there have been no changes to our significant accounting policies described in the Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on February 20, 2018, that have had a material impact on our consolidated financial statements.
In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (“ASU 2018-02”), which allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the U.S. Tax Cuts and Jobs Act (the “Tax Act”) signed into law in December 2017. We early adopted ASU 2018-02 effective January 1, 2018 and recorded an insignificant reclassification for the stranded tax effects resulting from the Tax Act from accumulated other comprehensive loss to retained earnings.
Summary of significant accounting policies
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 payment and transaction services; (iii) providing software maintenance and support services; and (iv) providing professional services, including implementation, consulting, training, analytic and other services. Revenues are recognized when control of these services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those services.
We determine revenue recognition through the following steps:
•Identification of the contract, or contracts, with a customer;
•Identification of the performance obligations in the contract;
•Determination of the transaction price;
•Allocation of the transaction price to the performance obligations in the contract; and
•Recognition of revenue when, or as, we satisfy a performance obligation.

Third Quarter 2018 Form 10-Q
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Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


Recurring
Recurring revenue represents stand-ready performance obligations in which we are making our solutions or services available to our customers continuously over time or the value of the contract renews. Therefore, recurring revenue is generally recognized over time on a ratable basis over the contract term, beginning on the date that the solution or service is made available to the customer. Our recurring revenue contracts are generally for a term of three years at contract inception with one to three-year renewals thereafter, billed annually in advance and non-cancelable.
Recurring revenue is comprised of fees for the use of our subscription-based software solutions, which includes providing access to cloud-based solutions, hosting services, online training programs, subscription-based analytic services, such as donor acquisitions and data enrichment, and payment services. Recurring revenue also includes fees from maintenance services for our on-premises solutions, services included in our renewable subscription contracts, subscription-based contracts for professional services and variable transaction revenue associated with the use of our solutions.
Our payment services are offered with the assistance of third-party vendors. In general, when we are the principal in a transaction based on the factors identified in ASC 606-10-55-36 through 55-40, 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 revenue (amount billed to the customer) and record the net amount as revenue. For payment and transaction services, we have the right to invoice the customer in an amount that directly corresponds with the value to the customer of our performance to date. Therefore, we recognize revenue for these services over time based on the amount billable to the customer in accordance with the 'as invoiced' practical expedient in ASC 606-10-55-18.
One-time services and other
One-time services and other revenue primarily consists of fees for one-time consulting, analytic and onsite training services.
We generally bill consulting services based on hourly rates plus reimbursable travel-related expenses. Fixed price consulting engagements are generally billed as milestones towards completion are reached. Revenue for all consulting services is recognized over time as the services are performed.
We generally recognize analytic services revenue from donor prospect research engagements, the sale of lists of potential donors, data enrichment engagements and benchmarking studies at a point in time (upon delivery).
In certain cases, 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.
Contracts with multiple performance obligations
Some of our contracts with customers contain multiple performance obligations. For these contracts, we account for individual performance obligations separately if they are distinct. The transaction price is allocated to the separate performance obligations on a relative standalone selling price basis. Standalone selling prices of our solutions and services are typically estimated based on observable transactions when the solutions or services are sold on a standalone basis.
Costs of obtaining contracts, contract assets and deferred revenue
We pay sales commissions at the time contracts with customers are signed or shortly thereafter, depending on the size and duration of the sales contract. Sales commissions and related fringe benefits earned by our sales force are considered incremental and recoverable costs of obtaining a contract with a customer. These costs are deferred and then amortized in a manner that aligns with the expected period of benefit, which we have determined to be five years. We determined the period of benefit by taking into consideration our customer contracts, including renewals, retention, our technology and other factors. We do not generally pay commissions for contract renewals. The related amortization expense is included in sales, marketing and customer success expense in our consolidated statements of comprehensive income.
Amounts recognized as revenue in excess of amounts billed are recorded as contract assets within prepaid expenses and other current assets on our consolidated balance sheets. To the extent that our customers are billed for our solutions and services in advance of us satisfying the related performance obligations, we record such amounts in deferred revenue.

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Third Quarter 2018 Form 10-Q

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


Recently issued accounting pronouncements
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. All entities will classify leases to determine how to recognize lease-related revenue and expense. Upon adoption, entities will be required to use a modified retrospective approach with an option to use certain practical expedients. We expect to adopt ASU 2016-02 when effective, using the transition method that allows us to initially apply the guidance at the adoption date of January 1, 2019 and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. We expect to use the package of practical expedients that allows us to not reassess: (1) whether any expired or existing contracts are or contain leases, (2) lease classification for any expired or existing leases and (3) initial direct costs for any expired or existing leases. We expect ASU 2016-02 will impact our consolidated financial statements and related disclosures. We are currently evaluating the extent of the impact and expect that most of our lease commitments will be subject to the updated guidance and recognized as lease liabilities and right-of-use assets on our consolidated balance sheets upon adoption.
3. Business Combinations

Reeher acquisition
On April 30, 2018, we acquired all of the outstanding equity securities, including all voting equity interests, of Reeher LLC, a Minnesota limited liability company (“Reeher”), pursuant to a securities purchase agreement. The acquisition expands our fundraising performance management capabilities and is intended to drive more effective fundraising and greater social good outcomes for our customers. We acquired the equity securities for an aggregate purchase price of $41.3 million in cash, subject to certain adjustments set forth in the securities purchase agreement. The purchase price and related expenses were funded primarily through borrowings under the 2017 Credit Facility (as defined below). As a result of the acquisition, Reeher has become a wholly-owned subsidiary of ours. The operating results of Reeher have been included in our consolidated financial statements from the date of acquisition. During the three and nine months ended September 30, 2018, we incurred insignificant acquisition-related expenses associated with the acquisition, which were recorded in general and administrative expense.
The fair values assigned to the assets acquired and liabilities assumed in the table below are based on our best estimates and assumptions as of the reporting date and are considered preliminary pending finalization. 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 intangible assets as well as the assumed deferred revenue and deferred income tax balances.
(in thousands)
Purchase price allocation

Net working capital, excluding deferred revenue
$
1,683

Property and equipment
755

Identifiable intangible assets
27,055

Deferred tax asset
713

Deferred revenue
(2,700
)
Goodwill
13,827

Total purchase price
$
41,333


The estimated fair value of accounts receivable acquired approximates the contractual value of $1.1 million and $11.8 million of the goodwill arising in the acquisition is deductible for income tax purposes. The estimated goodwill recognized is attributable primarily to the opportunities for expected synergies from combining the operations and assembled workforce of Reeher.

Third Quarter 2018 Form 10-Q
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Blackbaud, Inc.
Notes to consolidated financial statements (continued)
(Unaudited)


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

Weighted average amortization period
Reeher
 (in thousands)

(in years)
Acquired technology
$
18,900

11
Customer relationships
7,000

10
In-process research and development
600

Indefinite
Marketing assets
480

3
Non-compete agreements
75

2
Total intangible assets
$
27,055

11

The estimated fair values of the intangible assets were based on variations of the income approach, which estimates fair value based upon the present value of cash flows that the assets are expected to generate, and which included the relief-from-royalty method, incremental cash flow method, including the comparative (with and without) method and multi-period 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. Marketing assets and non-compete agreements are being amortized on a straight-line basis.
We determined that the impact of this acquisition was not material to our consolidated financial statements; therefore, revenue and earnings since the acquisition date and pro forma information are not required or presented.
4. Goodwill
The change in goodwill during the nine months ended September 30, 2018, consisted of the following:
(dollars in thousands)
Total
Balance at December 31, 2017
$
530,249

Additions related to current year business combinations
18,417

Adjustments related to prior year business combinations
(141
)
Effect of foreign currency translation
(1,187
)
Balance at September 30, 2018
$
547,338


5. 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.

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Third Quarter 2018 Form 10-Q

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


The following table sets forth the computation of basic and diluted earnings per share:
  
Three months ended 
 September 30,
 
 
Nine months ended 
 September 30,
 
(dollars in thousands, except per share amounts)
2018

2017

 
2018

2017

Numerator:
 
 
 
 
 
Net income
$
11,164

$
12,824

 
$
35,507

$
36,995

Denominator:
 
 
 
 
 
Weighted average common shares
47,279,591

46,711,709

 
47,174,903

46,627,213

Add effect of dilutive securities:
 
 
 
 
 
Stock-based awards
880,555

1,135,288

 
899,795

1,051,890

Weighted average common shares assuming dilution
48,160,146

47,846,997

 
48,074,698

47,679,103

Earnings per share:
 
 
 
 
 
Basic
$
0.24

$
0.27

 
$
0.75

$
0.79

Diluted
$
0.23

$
0.27

 
$
0.74

$
0.78

 
 
 
 
 
 
Anti-dilutive shares excluded from calculations of diluted earnings per share
—

1,719

 
—

4,938


6. Fair Value Measurements
We use a three-tier fair value hierarchy to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows:
•
Level 1 - Quoted prices for identical assets or liabilities in active markets;
•
Level 2 - Quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and
•
Level 3 - Valuations derived from valuation techniques in which one or more significant inputs are unobservable.

Third Quarter 2018 Form 10-Q
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13

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


Recurring fair value measurements
Assets and liabilities that are measured at fair value on a recurring basis consisted of the following, as of the dates indicated below:
 
Fair value measurement using
 
 
(dollars in thousands)
Level 1

 
Level 2

 
Level 3

 
Total

Fair value as of September 30, 2018
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
Derivative instruments
$
—

 
$
4,558

 
$
—

 
$
4,558

Total financial assets
$
—

 
$
4,558

 
$
—

 
$
4,558

 
 
 
 
 
 
 
 
Fair value as of December 31, 2017
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
Derivative instruments
$
—

 
$
1,283

 
$
—

 
$
1,283

Total financial assets
$
—

 
$
1,283

 
$
—

 
$
1,283


Our derivative instruments within the scope of ASC 815, Derivatives and Hedging, are required to be recorded at fair value. Our derivative instruments that are recorded at fair value include interest rate swaps.
The fair value of our interest rate swaps was based on model-driven valuations using LIBOR rates, which are observable at commonly quoted intervals. Accordingly, our interest rate swaps are classified within Level 2 of the fair value hierarchy.
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 September 30, 2018 and December 31, 2017, due to the immediate or short-term maturity of these instruments.
We believe the carrying amount of our debt approximates its fair value at September 30, 2018 and December 31, 2017, as the debt bears interest rates that approximate market value. As LIBOR rates are observable at commonly quoted intervals, our debt is classified within Level 2 of the fair value hierarchy.
We did not transfer any assets or liabilities among the levels within the fair value hierarchy during the nine months ended September 30, 2018. Additionally, we did not hold any Level 3 assets or liabilities during the nine months ended September 30, 2018.
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, are based on Level 3 unobservable inputs. In the event of an impairment, we determine the fair value of the intangible assets other than goodwill using a discounted cash flow approach, which contains significant unobservable inputs and, therefore, is considered a Level 3 fair value measurement. The unobservable inputs in the analysis generally include future cash flow projections and a discount rate. For goodwill impairment testing, we estimate fair value using market-based methods including the use of market capitalization and consideration of a control premium.
There were no non-recurring fair value adjustments to intangible assets and goodwill during the nine months ended September 30, 2018, except for an insignificant business combination accounting adjustment to the initial fair value estimates of the assets acquired and liabilities assumed at the acquisition date from updated information obtained during the measurement period. See Note 4 to these consolidated financial statements for additional details. The measurement period of a business combination 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.

14
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Third Quarter 2018 Form 10-Q

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


7. Consolidated Financial Statement Details
Prepaid expenses and other assets
(dollars in thousands)
September 30,
2018

December 31,
2017

Costs of obtaining contracts(1)
$
83,267

$
77,312

Prepaid software maintenance and subscriptions
21,750

17,402

Taxes, prepaid and receivable
6,319

10,548

Derivative instruments
4,558

1,283

Contract assets
4,415

3,136

Security deposits
2,793

2,305

Other assets
11,252

7,230

Total prepaid expenses and other assets
134,354

119,216

Less: Long-term portion
65,512

57,238

Prepaid expenses and other current assets
$
68,842

$
61,978


(1)
Amortization expense from costs of obtaining contracts was $26.6 million for the nine months ended September 30, 2018.
Accrued expenses and other liabilities
(dollars in thousands)
September 30,
2018

December 31,
2017

Accrued bonuses
$
13,281

$
16,743

Accrued commissions and salaries
7,855

6,943

Lease incentive obligations
3,881

4,635

Customer credit balances
3,928

4,652

Deferred rent liabilities
2,788

4,548

Taxes payable
3,247

5,517

Unrecognized tax benefit
3,017

1,972

Accrued vacation costs
2,364

2,458

Accrued health care costs
2,411

2,615

Other liabilities
8,646

9,948

Total accrued expenses and other liabilities
51,418

60,031

Less: Long-term portion
7,027

5,632

Accrued expenses and other current liabilities
$
44,391

$
54,399


Other (expense) income, net
  
Three months ended 
 September 30,
 
 
Nine months ended 
 September 30,
 
(dollars in thousands)
2018

2017

 
2018

2017

Interest income
$
943

$
393

 
$
1,613

$
771

Gain (loss) on derivative instrument
—

(3
)
 
—

472

Loss on debt extinguishment
—

(137
)
 
—

(299
)
Other (expense) income, net
(1,090
)
215

 
(1,254
)
637

Other (expense) income, net
$
(147
)
$
468

 
$
359

$
1,581



Third Quarter 2018 Form 10-Q
bblogo.jpg
15

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


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)
September 30,
2018

December 31,
2017

 
September 30,
2018

December 31,
2017

Credit facility:
 
 
 
 
 
    Revolving credit loans
$
135,300

$
143,000

 
3.99
%
2.84
%
    Term loans
290,625

296,250

 
3.35
%
2.64
%
Other debt
1,076

1,076

 
4.50
%
4.50
%
        Total debt
427,001

440,326

 
3.56
%
2.71
%
Less: Unamortized discount and debt issuance costs
1,745

2,102

 
 
 
Less: Debt, current portion
8,576

8,576

 
3.62
%
3.03
%
Debt, net of current portion
$
416,680

$
429,648

 
3.55
%
2.71
%


In June 2017, we entered into a five-year $700.0 million senior credit facility (the "2017 Credit Facility"). As of September 30, 2018, the required annual maturities related to the 2017 Credit Facility and other debt were as follows:
Years ending December 31,
(dollars in thousands)
Annual maturities

2018 - remaining
$
2,951

2019 
7,500

2020 
7,500

2021 
7,500

2022 
401,550

Thereafter
—

Total required maturities
$
427,001


9. Derivative Instruments
Cash flow hedges
We generally use derivative instruments to manage our variable interest rate risk. In July 2017, we entered into an interest rate swap agreement (the "July 2017 Swap Agreement"), which effectively converts portions of our variable rate debt under our credit facility to a fixed rate for the term of the July 2017 Swap Agreement. The notional value of the July 2017 Swap Agreement was $150.0 million with an effective date beginning in July 2017 through July 2021. We designated the July 2017 Swap Agreement as a cash flow hedge at the inception of the contract.
In February 2018, we entered into an additional interest rate swap agreement (the "February 2018 Swap Agreement"), which effectively converts portions of our variable rate debt under our credit facility to a fixed rate for the term of the February 2018 Swap Agreement. The notional value of the February 2018 Swap Agreement was $50.0 million with an effective date beginning in February 2018 through June 2021. We designated the February 2018 Swap Agreement as a cash flow hedge at the inception of the contract.

16
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Third Quarter 2018 Form 10-Q

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


Undesignated contracts
In June 2017, we entered into a foreign currency option contract to hedge our exposure to currency fluctuations in connection with our acquisition of JustGiving because the purchase price was denominated in British Pounds. The notional value of the instrument was £100.0 million with an effective date beginning in June 2017 and maturing in September 2017. We settled the foreign currency option contract in September 2017. We did not designate the foreign currency option contract as a cash flow hedge for accounting purposes since it involved a business combination. As such, changes in the fair value of this derivative were recognized in earnings. The insignificant premium paid for this option and the proceeds from settlement are shown within cash flows from investing activities in our consolidated statements of cash flows.
As the closing date of our acquisition of JustGiving extended beyond the settlement date of the foreign currency option contract, we entered into a foreign currency forward contract in September 2017 with settlement in October 2017. The notional value of the instrument was £103.5 million. We did not designate the foreign currency forward contract as a cash flow hedge for accounting purposes since it involved a business combination. As such, changes in the fair value of this derivative were recognized in earnings.
The fair values of our derivative instruments were as follows as of:
 
 
Asset Derivatives
 
 
Liability Derivatives
(dollars in thousands)
Balance sheet location
September 30,
2018

December 31,
2017

 
Balance sheet location
September 30,
2018

December 31,
2017

Derivative instruments designated as hedging instruments:
 
 
 
 
 
 
 
Interest rate swaps, current portion
Prepaid expenses
and other current assets
$
—

$
145

 
Accrued expenses
and other current liabilities
$
—

$
—

Interest rate swaps, long-term portion
Other assets
4,558

1,138

 
Other liabilities
—

—

Total derivative instruments designated as hedging instruments
 
$
4,558

$
1,283

 
 
$
—

$
—


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)
September 30,
2018

Three months ended 
 September 30, 2018

 
Nine months ended 
 September 30, 2018

Interest rate swaps
$
4,558

Interest expense
$
23

 
$
(17
)
 
 
 
 
 
 
 
September 30,
2017

 
Three months ended 
 September 30, 2017

 
Nine months ended 
 September 30, 2017

Interest rate swaps
$
(105
)
Interest expense
$
(88
)
 
$
(192
)

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 income as of September 30, 2018 that is expected to be reclassified into earnings within the next twelve months is $1.2 million. There were no ineffective portions of our interest rate swap derivatives during the nine months ended September 30, 2018 and 2017. See Note 13 to these consolidated financial statements for a summary of the changes in accumulated other comprehensive income (loss) by component.

Third Quarter 2018 Form 10-Q
bblogo.jpg
17

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


We did not have any undesignated derivative instruments during 2018. The effects of undesignated derivative instruments during the three and nine months ended September 30, 2017 were as follows:
 
Location of gain (loss)
recognized in income on derivative
Gain (loss) recognized in income
 
(dollars in thousands)
Three months ended 
 September 30, 2017

 
Nine months ended 
 September 30, 2017

Foreign currency option contracts
Other income (expense), net
$
38

 
$
513

Foreign currency forward contracts
Other income (expense), net
$
(41
)
 
$
(41
)
Total (loss) gain(1)
 
$
(3
)
 
$
472


(1)
The individual amounts for each year may not sum to total gain (loss) due to rounding.
10. Commitments and Contingencies
Leases
Total rent expense was $6.2 million and $3.8 million for the three months ended September 30, 2018 and 2017, respectively, and $16.2 million and $11.9 million, respectively, for the nine months ended September 30, 2018 and 2017.
Other commitments
The term loans under the 2017 Credit Facility require periodic principal payments. The balance of the term loans and any amounts drawn on the revolving credit loans are due upon maturity of the 2017 Credit Facility in June 2022.
We have contractual obligations for third-party technology used in our solutions and for other services we purchase as part of our normal operations. In certain cases, these arrangements require a minimum annual purchase commitment by us. As of September 30, 2018, the remaining aggregate minimum purchase commitment under these arrangements was approximately $66.4 million through 2023.
Solution and service indemnifications
In the ordinary course of business, we provide certain indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of our solutions or services. If we determine that it is probable that a loss has been incurred related to solution or service indemnifications, any such loss that could be reasonably estimated would be recognized. We have not identified any losses and, accordingly, we have not recorded a liability related to these indemnifications.
Legal proceedings
We are subject to legal proceedings and claims that arise in the ordinary course of business. We make a provision for a loss contingency when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. Unless otherwise specifically disclosed in this note, we have determined as of September 30, 2018, that no provision for liability nor disclosure is required related to any claim against us because (a) there is not a reasonable possibility that a loss exceeding amounts already recognized (if any) may be incurred with respect to such claim; (b) a reasonably possible loss or range of loss cannot be estimated; or (c) such estimate is immaterial.
All legal costs associated with litigation are expensed as incurred. Litigation is inherently unpredictable. However, we believe that we have valid defenses with respect to the legal matters pending against us. It is possible, nevertheless, that our consolidated financial position, results of operations or cash flows could be negatively affected in any particular period by an unfavorable resolution of one or more of such proceedings, claims or investigations.

18
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Third Quarter 2018 Form 10-Q

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


11. Income Taxes
Our income tax provision (benefit) and effective income tax rates, including the effects of period-specific events, were:
  
Three months ended 
 September 30,
 
 
Nine months ended 
 September 30,
 
(dollars in thousands)
2018

2017

 
2018

2017

Income tax provision (benefit)
$
332

$
2,975

 
$
(2,370
)
$
4,120

Effective income tax rate
2.9
%
18.8
%
 
(7.2
)%
10.0
%

The decrease in our effective income tax rate during the nine months ended September 30, 2018, when compared to the same period in 2017, was primarily due to the impact of the discrete benefit to income tax expense relating to stock-based compensation items, calculated prior to the impact of the U.S. federal corporate tax rate change as a result of the Tax Act. This favorable impact was attributable to an increase in the market price for shares of our common stock, as reported by the Nasdaq Stock Market LLC ("Nasdaq"), as well as an increase in the number of stock awards that vested and were exercised. Most of our equity awards are granted during our first quarter and vest in subsequent years during the same quarter. The discrete benefit to income tax expense relating to stock-based compensation during the three and nine months ended September 30, 2018 was reduced as a result of the decrease in the U.S. corporate tax rate.

The decreases in our effective income tax rates during the three and nine months ended September 30, 2018, as compared to the same periods in 2017, were also attributable to the impact of the lower U.S. federal corporate tax rate on pre-tax income and the release of our tax reserve due to the expiration of the federal statute of limitations for 2014.

In December 2017, the Tax Act was signed into law making significant changes to the Internal Revenue Code. Changes include, but are not limited to, a corporate tax rate decrease from 35% to 21% effective for tax years beginning after December 31, 2017, the transition of U.S. international taxation from a worldwide tax system to a territorial system, and a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017.

On December 22, 2017, Staff Accounting Bulletin No. 118 (“SAB 118”) was issued to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act. For the three and nine months ended September 30, 2018, the Company finalized its calculation of the transition tax as of December 31, 2017, and the impact to our effective income tax rate was insignificant.

The Tax Act eliminates the exceptions for performance-based compensation and CFO compensation from the calculation under Section 162(m) of the Internal Revenue Code. A transition rule allows for the grandfathering of performance-based compensation pursuant to a written binding contract in effect as of November 2, 2017. On August 21, 2018, the Internal Revenue Service issued Notice 2018-68 providing guidance regarding amendments to Section 162(m) contained in the Tax Act, including application of the transition rule. As a result of this guidance, the Company finalized its calculations of the Section 162(m) deduction and the ending estimated deferred tax assets for the performance-based stock compensation and the bonus accrual, which resulted in an insignificant impact to our effective income tax rate.

Our estimates of the impact of the Tax Act may change due to a number of additional considerations including, but not limited to, the issuance of additional regulations or guidance and our ongoing analysis of the new law. Any subsequent adjustment to these amounts will be recorded to tax expense when the analysis is complete.


Third Quarter 2018 Form 10-Q
bblogo.jpg
19

Blackbaud, Inc.
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 
 September 30,
 
 
Nine months ended 
 September 30,
 
(dollars in thousands)
2018

2017

 
2018

2017

Included in cost of revenue:
 
 
 
 
 
Cost of recurring
$
616

$
434

 
$
1,786

$
1,257

Cost of one-time services and other
654

500

 
2,224

1,418

Total included in cost of revenue
1,270

934

 
4,010

2,675

Included in operating expenses:
 
 
 
 
 
Sales, marketing and customer success
2,234

1,686

 
6,866

4,906

Research and development
2,153

2,093

 
6,737