BLACKBAUD INC 10-K

ITEM 7. 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 Item 1A Risk factors and our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. The following discussion and analysis presents financial information denominated in millions of dollars which can lead to differences from rounding when compared to similar information contained in the consolidated financial statements and related notes, which are primarily denominated in thousands of dollars. Executive Summary We are the world’s leading cloud software company powering social good. Serving the entire social good community—nonprofits, higher education institutions, K–12 schools, healthcare organizations, faith communities, arts and cultural organizations, foundations, companies and individual change agents—we connect and empower organizations and individuals 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 nearly four 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 December 31, 2020, we had over 45,000 global customers. Our revenue is primarily generated from the following sources: (i) charging for the use of our software solutions in cloud and hosted environments; (ii) providing payment and transaction services; (iii) providing software maintenance and support services; and (iv) providing professional services, including implementation, consulting, training, analytic and other services. COVID-19 Impact The outbreak of COVID-19 in countries across the globe, including each country in which we currently operate, has adversely impacted the U.S. and global economies. We began 2020 with strong execution against our financial plan. In March 2020, we began to experience disruptions to our business from COVID-19, and the pandemic continues to impact each of our markets. To better enable us to weather the extraordinary business challenges brought about by the global COVID-19 pandemic, to protect the safety and welfare of our employees, and to further effect our long-term strategy to deliver the greatest value to our stockholders, we have taken several actions. These measures taken are expected to provide us the financial flexibility needed to manage a wide array of outcomes that may result from COVID-19. See Note 2 to our condensed consolidated financial statements in this report for a discussion of some of these actions. In addition to the actions we have taken to date, we are continuously evaluating further possible actions in order to respond quickly to rapidly changing conditions, if needed. The economic impact of COVID-19 on the social good industry remains uncertain. With our existing and prospective customers remaining cautious in their purchase decisions, we expect that our operating environment may continue to be challenging in 2021 and potentially beyond, as discussed below. Notwithstanding these conditions, we remain focused on continuing to execute our four-point growth strategy and strengthening our leadership position. 32 2020 Form 10-K Table of Contents Blackbaud, Inc. Four-Point Growth Strategy 1 Delight Customers with Innovative Cloud Solutions 2 Drive Sales Effectiveness 3 Expand Total Addressable Market 4 Improve Operating Efficiency 1. Delight Customers with Innovative Cloud Solutions This strategy reflects our relentless focus on driving value and outcomes for our customers through our solutions. Blackbaud SKY®, our platform for cloud innovation, is a core tenant of this strategy and continues to power an elevated level of innovation by our engineers. It is also enabling our growing ecosystem of partners who are also passionate about social good, to extend and expand the capabilities available to our customers. During 2020, we continued making critical investments in research and development and increased our engineering hiring during the fourth quarter. We also released the Blackbaud Marketplace during 2020, offering curated third-party apps, enabling organizations of all types and sizes to discover new ways to amplify their impact by enhancing their best-of-breed Blackbaud solutions with specialized capabilities like connecting bidders at fundraising auctions, tracking branded merchandise purchased in an online store or texting volunteers about an upcoming event. The customers we serve require vertical specific business solutions to automate their operations. Throughout 2020 we have remained focused on driving value and outcomes for our customers. We reprioritized and expedited product enhancements to support our customers needs, especially in light of COVID-19 and the continued shift to virtual, digital-first operating models. For example, we released fitness tracking integration in Blackbaud’s peer-to-peer fundraising portfolio, a new virtual prayer wall enabling congregants at houses of worship to share and respond to prayer requests online, text messaging capabilities for scholarship directors and higher education institutions to ensure no funds were going unutilized and expanded the global capabilities of YourCause CSRConnect making it easier for companies to bring employees across geographies together in support of causes around the world. Blackbaud Peer-to-Peer Fundraising powered by JustGiving continues to gain traction. During 2020, we migrated everydayhero customers over to Blackbaud Peer-to-Peer Fundraising powered by JustGiving and sunset the everydayhero product as we continue to rationalize our portfolio while continuing to delight our customers with innovative cloud solutions. 2. Drive Sales Effectiveness We have been investing in sales and marketing to better address our market opportunity with a focus on digital lead generation. One way we are equipping our salesforce to be more effective is by investing in the necessary technology and resources to efficiently drive an increased number of quality leads and better cover our large addressable market. We have implemented software tools to enhance our digital footprint and drive lead generation across the company. We are taking a multi-touch attribution approach to measuring the effectiveness of our marketing campaigns to drive efficiency in our go-to-market efforts and improve returns on our marketing dollars. This is just one of many examples of how we are optimizing our structure, tools and processes to better address our large vertical market opportunities. We have also taken lessons learned throughout 2020 and re-evaluated elements of our go-to-market strategy with a digital-first mindset and we have a significant opportunity to leverage the investments into digital to reduce our customer acquisition cost and increase our sales velocity, ultimately, driving a more scalable and cost-effective go-to-market model. 3. Expand TAM We did not complete any acquisitions during 2020 as we have remained vigilantly focused on supporting our customers and employees during this time. We remain active in the evaluation of opportunities to further expand 2020 Form 10-K 33 Table of Contents Blackbaud, Inc. our addressable market through acquisitions and internal product development. We believe we have significant opportunities in front of us as we are less than 10% penetrated into a total addressable market of over $10 billion. 4. Improve Operating Efficiency We are also focused on operational efficiency to strengthen the business and position us for long-term success. During 2020, we pivoted to place a greater emphasis on profit in alignment with the balanced approach management takes to operating the business. As a result of the pandemic, our near term visibility into revenue growth was impacted and we took certain actions early on to ensure our near-term liquidity (as discussed above) and shifted more of our focus to profitability. Our employees switched to working fully remote at the onset of the pandemic and the business continued operating smoothly. This caused us to re-evaluate our workforce strategy and when employees return to the office, we expect to have more employees working remotely either part-time or full time, even within our hub locations. As a result, we revisited our real estate strategy with a focus on optimizing our footprint for the future of work at Blackbaud, including the purchase of our LEED Gold certified Global Headquarters Facility and exit of certain office leases globally. Our aim is optimizing our office utilization, improving our geographic sales coverage and enhancing our employees' daily experience to improve productivity and effectiveness. Financial Summary Total Revenue ($M) Income from Operations ($M) YoY Growth (%) YoY Growth (%) Total revenue increased by $12.8 million during 2020, driven largely by the following: + Increase in transactional revenue, including an accelerated shift toward virtual and online fundraising and charitable giving related to COVID-19 + Increase in contractual recurring revenue related to positive demand from customers across our portfolio of cloud solutions - Decrease in one-time consulting revenue primarily from less one-time sales related to changes in our compensation plans to place greater emphasis on subscription sales of our cloud solutions - Decrease in one-time analytics revenue as analytics are generally integrated in our cloud solutions 34 2020 Form 10-K Table of Contents Blackbaud, Inc. Income from operations increased by $10.1 million during 2020, driven largely by the following: + Growth in total revenue, as described above + Decrease in compensation costs (excluding stock-based compensation expense) of $43.7 million primarily associated with the decision to replace our 2020 cash bonus plans with grants of performance-based equity awards, which are being recognized as stock-based compensation expense between May 1, 2020 and May 1, 2021. These awards may be earned and become eligible for vesting on May 1, 2021 subject to meeting certain performance conditions and the recipient's continued employment with us + Decrease in travel costs of $11.0 million due to our restriction on non-essential employee travel in response to the COVID-19 pandemic + Decrease in amortization of intangible assets from business combinations of $8.2 million + Decrease in restructuring costs of $5.6 million as our facilities optimization restructuring plan was largely completed as of December 31, 2019 + Decrease in acquisition-related expenses and integration costs of $3.3 million - Increase in stock-based compensation expense of $28.6 million primarily related to the decision to replace our 2020 cash bonus plans with grants of performance-based equity awards - Increase in real estate activity costs of $23.1 million due to our workforce strategy changes in response to the COVID-19 pandemic. For additional details, see "Results of Operations - General and administrative" below. - Increase in corporate costs of $6.3 million primarily related to increases in bad debt expense; for additional details, see Note 2 to our consolidated financial statements in this report - Increase in cost of revenue from a $4.3 million impairment charge during the three months ended June 30, 2020, against certain previously capitalized software development costs, resulting from our decision to accelerate the end of customer support for certain solutions - Other increases in cost of revenue related to increases in data center costs, amortization of software development costs and transaction-based costs There are three primary revenue categories with related business drivers that we continue to monitor closely in light of the COVID-19 pandemic: 1. Contractual Recurring Revenue (approximately two thirds of total revenue in 2020) Recurring subscription contracts are typically for a term of three years at contract inception, billed annually in advance, and we have been for several years successfully shifting our legacy customer base away from annual renewals and moving them onto multi-year renewal contracts. Our contracted recurring revenue has performed well as our renewal rate during 2020 finished favorable to our original plan. We expect the shortfall in bookings during 2020 to put pressure on our revenue growth during 2021. We are closely monitoring our customer receivable balances, payment terms, and creditworthiness. While we experienced an increase in our aging of receivables during the second and third quarters of 2020 primarily associated with the COVID-19 pandemic, we have seen some improvement in our customers' payment behavior since that time. We also saw fewer of our customers go out of business during 2020 than 2019, which demonstrated the resiliency of our market. 2. Transactional Revenue (approximately one quarter of total revenue in 2020) Transactional revenue is non-contractual and less predictable given the susceptibility to certain drivers such as timing and number of events and marketing campaigns, as well as fluctuations in donation volumes and tuition payments. We have historically experienced seasonal highs during the fourth quarter due to year-end giving campaigns and during the second quarter when a large number of events are held. During the fourth quarter, we saw our payments transaction volumes exceed our expectations due primarily to year-end giving to our customers. For the full year, we saw the negative impact of many in-person events being postponed or canceled. Social good organizations have been forced to employ new strategies to maintain momentum with current supporters while capturing the attention of potential new donors. We continue to support our customers in adapting to these circumstances through virtual campaigns and events. 2020 Form 10-K 35 Table of Contents Blackbaud, Inc. 3. Bookings Our first quarter has historically been the seasonal low for bookings, with the second and fourth quarters historically being seasonally higher, and our bookings tend to be back-end loaded within individual quarters given our quarterly quota plans. During 2020, we had a significant shortfall in bookings compared to both our original plan for the year and our prior year performance, as we experienced challenges in building pipeline after the start of the pandemic. Given our ratable revenue recognition model for our recurring subscription contracts and implementation periods, we expect that the declines in our 2020 bookings performance will have a greater negative impact on our 2021 revenue than it did our 2020 revenue. We believe the current environment has put a greater emphasis on investing in digital and cloud solutions and are optimistic this may result in an increase in pipeline and bookings at some point in 2021. Our strategy has historically relied on a balanced approach to growth and profitability. As discussed above, the pandemic has created short-term uncertainty in our revenue outlook and the early impacts on pipeline and bookings will likely limit our ability to drive near-term revenue growth at our originally planned levels. Therefore, in line with our strategy, we have made a pivot to greater emphasis on delivering shareholder value through increased profitability and cash flow, which are more controllable. Customer Retention Our recurring revenue contracts are generally for a term of three years at contract inception with one to three-year renewals thereafter. We anticipate a continued decrease in maintenance contract renewals as we transition our solution portfolio and maintenance customers from a perpetual license-based model to a cloud subscription delivery model. In the long term, we also anticipate an increase in recurring subscription contract renewals as we continue focusing on innovation, quality and the integration of our cloud solutions, which we believe will provide value-adding capabilities to better address our customers' needs. Due primarily to these factors, we believe a recurring revenue customer retention measure that combines recurring subscription, maintenance and service customer contracts provides a better representation of our customers' overall behavior. During 2020 and 2019, approximately 93% and 92%, respectively, of our customers with recurring revenue contracts were retained. This customer retention rate reflects our efforts to rationalize our portfolio of solutions and migrate customers from legacy solutions towards our next generation cloud solutions. We are investing in innovation, which we believe will increase customer retention over the long-term. Balance Sheet and Cash Flow At December 31, 2020, our cash and cash equivalents were $35.8 million and the carrying amount of our debt under the 2020 Credit Facility was $467.1 million. Our net leverage ratio was 1.75 to 1.00. During 2020, we generated $148.0 million in cash flow from operations, primarily from operating cost reductions put in place in response to COVID-19 and the increased use of stock-based compensation. During 2020, we had a net increase in borrowings of $0.9 million, we returned $47.0 million to stockholders by way of share repurchases and dividends, and had cash outlays of $71.8 million for purchases of property and equipment and capitalized software development costs. A larger amount of cash was spent on property and equipment during 2020 primarily due to the purchase of our Global Headquarters Facility. 36 2020 Form 10-K Table of Contents Blackbaud, Inc. Results of Operations Reportable segment We report our operating results and financial information in one operating and reportable segment. See Note 16 of our consolidated financial statements in this report for additional information. Comparison of 2020 vs. 2019 and 2019 vs. 2018 Acquisitions During 2019 and 2018, we acquired companies that provided us with strategic opportunities to expand our TAM and share of the philanthropic giving market through the integration of complementary solutions and services to serve the changing needs of our customers. The following are the companies we acquired and their respective acquisition dates: • YourCause Holdings, LLC ("YourCause") on January 2, 2019 • Reeher LLC ("Reeher") on April 30, 2018 We have included the results of operations of acquired companies in our consolidated results of operations from the date of their respective acquisition. We determined that the YourCause and Reeher acquisitions were not material business combinations; therefore, revenue and earnings since the acquisition dates and pro forma information are not required or presented. See Note 3 to our consolidated financial statements in this report for a summary of these acquisitions. Revenue and Cost of Revenue Recurring Revenue ($M) Cost of revenue ($M) Gross profit ($M) and gross margin (%) YoY Growth (%) YoY Growth (%) Recurring revenue is comprised of fees for the use of our subscription-based software solutions, which includes providing access to cloud solutions, hosting services, payment services, online training programs, subscription-based analytic services, such as donor acquisitions and data enrichment services. Recurring revenue also includes fees from maintenance services for our on-premises solutions, services included in our renewable subscription contracts, retained and managed services contracts that we expect to have a term consistent with our cloud solution contracts, and variable transaction revenue associated with the use of our solutions. Cost of recurring revenue is primarily comprised of compensation costs for customer support and production IT personnel, hosting and data center costs, third-party contractor expenses, third-party royalty and data expenses, allocated depreciation, facilities and IT support costs, amortization of intangible assets from business combinations, amortization of software development costs, transaction-based costs related to payments services including remittances of amounts due to third-parties and other costs incurred in providing support and recurring services to our customers. 2020 Form 10-K 37 Table of Contents Blackbaud, Inc. Our customers continue to prefer cloud subscription offerings with integrated analytics, training and payment services. Recurring subscription contracts are typically for a term of three years at contract inception with one to three-year renewals thereafter. We intend to continue focusing on innovation, quality and integration of our cloud solutions, which we believe will drive future revenue growth. 2020 vs. 2019 Recurring revenue increased by $19.1 million, or 2.3%, driven primarily by the following: + Increase in transactional revenue of $18.3 million, including an accelerated shift toward virtual and online fundraising and charitable giving related to COVID-19 + Increase in contractual recurring revenue of $15.5 million related to positive demand from customers across our portfolio of cloud solutions - Decrease in maintenance revenue of $14.7 million primarily related to our continuing efforts to migrate customers from legacy on-premises solutions onto our solutions powered by Blackbaud SKY, our modern cloud platform Partially offsetting contractual recurring revenue was a decrease in the mix of retained and managed services contracts we present in recurring revenue. Revenue from retained and managed service contracts that we do not expect to have a term consistent with our cloud solution contracts is included in one-time services and other revenue beginning January 1, 2020. This change in presentation resulted in a decrease in recurring revenue and an offsetting increase to one-time services and other revenue of $16.7 million during the twelve months ended December 31, 2020. Cost of recurring revenue increased by $11.7 million, or 3.3%, driven primarily by the following: + Increase in transaction-based costs of $7.5 million related to payment services integrated in our cloud solutions + Increase in amortization of software development costs of $6.8 million due to investments made on innovation, quality and the integration of our cloud solutions + Impairment charge of $4.3 million during the three months ended June 30, 2020, against certain previously capitalized software development costs that reduced the carrying value of those assets to zero. The impairment charge resulted primarily from our decision to accelerate the end of customer support for certain solutions. + Increase in hosting and data center costs of $3.8 million as we are migrating our cloud infrastructure to leading public cloud service providers - Decrease in amortization of intangible assets from business combinations of $5.7 million - Decrease in compensation costs primarily associated with the decision to replace our 2020 cash bonus plans with grants of performance-based equity awards, which are being recognized as stock-based compensation expense between May 1, 2020 and May 1, 2021. These awards may be earned and become eligible for vesting on May 1, 2021 subject to meeting certain performance conditions and the recipient's continued employment with us - Decrease in costs associated with certain retained and managed services contracts for which revenue is included in one-time services and other revenue beginning January 1, 2020, as discussed above Recurring gross margin decreased by 0.4%, driven primarily by an increase in the mix of payments revenue, which generally have lower gross margins than our contractual recurring revenue, the impairment of previously capitalized software development costs, and incremental costs associated with our continued shift toward selling cloud solutions, including data center costs and amortization of software development costs. We expect continued pressure on recurring gross margin largely driven by duplicate data center costs as we migrate our cloud infrastructure to leading cloud service providers. 2019 vs. 2018 Recurring revenue increased by $69.4 million, or 9.1%, driven primarily by the following: + Increase in subscriptions revenue of $87.8 million related to positive demand across our portfolio of cloud solutions and, to a lesser extent, the inclusion of YourCause, an increase in services embedded in our renewable cloud solution contracts and increased sales of subscription-based retained professional services - Decrease in maintenance revenue of $18.4 million primarily related to our continuing efforts to migrate customers from legacy on-premises solutions onto our solutions powered by Blackbaud SKY, our modern cloud platform 38 2020 Form 10-K Table of Contents Blackbaud, Inc. Cost of recurring revenue increased by $52.5 million, or 17.2%, driven primarily by the following: + Increase in transaction-based costs of $13.0 million, related to payment services integrated in our cloud solutions + Increase in compensation costs of $11.2 million, primarily attributable to an increasing portion of our resources providing subscription-based retained services as opposed to one-time + Increase in hosting and data center costs of $5.4 million due to the migration of our cloud infrastructure to leading public cloud service providers + Increase in third-party data and tool costs of $5.1 million + Increase in allocated corporate costs of $5.1 million primarily due to investments in corporate IT, including cyber security and increases in related headcount + Increase in amortization of software development costs of $4.1 million due to investments made on innovation, quality and the integration of our cloud solutions Recurring gross margin decreased by 3.0%, driven primarily by incremental costs associated with our continued shift toward selling cloud solutions and retained services, including hosting and data center costs, compensation costs and amortization of software development costs. One-time services and other Revenue ($M) Cost of revenue ($M) Gross profit ($M) and gross margin (%) YoY Growth (%) YoY Growth (%) One-time services and other revenue is comprised of fees for one-time consulting, analytic and onsite training services, fees for retained and managed services contracts that we do not expect to have a term consistent with our cloud solution contracts, revenue from the sale of our software sold under perpetual license arrangements, fees from user conferences and third-party software referral fees. Cost of one-time services and other is primarily comprised of compensation costs for professional services and onsite training personnel, other costs incurred in providing onsite customer training, third-party contractor expenses, data expense incurred to perform one-time analytic services, third-party software royalties, costs of user conferences, allocated depreciation, facilities and IT support costs and amortization of intangible assets from business combinations. 2020 Form 10-K 39 Table of Contents Blackbaud, Inc. 2020 vs. 2019 One-time services and other revenue decreased by $6.3 million, or 9.2%, driven primarily by the following: + Increase in the mix of retained and managed services contracts we present in one-time services and other. Revenue from retained and managed service contracts that we do not expect to have a term consistent with our cloud solution contracts is included in one-time services and other revenue beginning January 1, 2020. This change in presentation resulted in an increase to one-time services and other revenue and an offsetting decrease in recurring revenue of $16.7 million during the twelve months ended December 31, 2020. - Decrease in one-time consulting revenue of $12.1 million primarily from less one-time sales related to changes in our compensation plans to place greater emphasis on subscription sales of our cloud solutions. Services increasingly being embedded in our renewable cloud solution contracts also contributed to the decrease in one-time services revenue. Our embedded services are recorded as recurring revenue. - Decrease in one-time analytics revenue of $4.2 million as analytics are generally integrated in our cloud solutions - Decrease in conference revenue of $3.6 million as our annual conference, bbcon, was held virtually and provided free of charge - Decrease in onsite training revenue of $1.3 million due to COVID-19 Cost of one-time services and other decreased $2.1 million or 3.4%, primarily driven by the following: + Increase in compensation costs of $3.4 million primarily related to an increase in stock-based compensation expense as we replaced our 2020 cash bonus plans and annual merit-based salary increases for our employees with grants of equity awards - Decrease of $4.2 million in costs related to providing our annual user conference, bbcon, virtually - Insignificant decrease in travel costs due to our restriction on non-essential employee travel in response to COVID-19 One-time services and other gross margin decreased by 5.6%, primarily as the reductions in one-time consulting and analytics revenue discussed above outpaced the decrease in related costs. 2019 vs. 2018 One-time services and other revenue decreased by $17.6 million, or 20.4%, driven primarily by the following: - Decrease in one-time consulting revenue of $12.6 million. Services are increasingly embedded in our renewable cloud solution contracts and we are selling more subscription-based contracts for retained professional services. Our embedded services are recorded as recurring revenue. - Decrease in one-time analytics revenue of $3.8 million as analytics are generally integrated in our cloud solutions Cost of one-time services and other decreased by $15.8 million, or 20.8%, driven primarily by a decrease in compensation costs of $13.3 million. The decrease in compensation costs was in line with the decrease in one-time services sold and delivered as an increasing portion of our resources provided subscription-based retained services as opposed to one-time. One-time services and other gross margin increased by 0.4%, as the reductions in costs of one-time services and other discussed above slightly outpaced the declines in one-time consulting revenue and analytics revenue associated with the shift in our go-to-market strategy. 40 2020 Form 10-K Table of Contents Blackbaud, Inc. Operating Expenses Sales, marketing and customer success ($M) Research and development ($M) General and administrative ($M) Percentages indicate expenses as a percentage of total revenue Sales, marketing and customer success Sales, marketing and customer success expense includes compensation costs, variable sales commissions, travel-related expenses, advertising and marketing materials, public relations costs, variable reseller commissions and allocated depreciation, facilities and IT support costs. We see a large market opportunity in the long-term and will continue to make investments to drive sales effectiveness, which is a component of our four-point growth strategy. We have also implemented software tools to enhance our digital footprint and drive lead generation. In response to the COVID-19 pandemic, we implemented a modest and targeted headcount reduction during the second quarter, including a reduction in our sales headcount with a focus on retaining our most highly productive sales executives. The enhancements we are making in our go-to-market approach are expected to significantly reduce the payback period for our customer acquisition costs while increasing sales velocity. As a result, we do not expect our sales, marketing and customer success expense to return to pre-pandemic levels. 2020 vs. 2019 Sales, marketing and customer success expenses decreased by $14.4 million, or 6.4%. The decreases in dollars and as a percentage of total revenue were primarily driven by the following: - Decrease in compensation costs of $6.5 million primarily related to the decision to replace our 2020 cash bonus plans with grants of performance-based equity awards, which are being recognized as stock-based compensation expense between May 1, 2020 and May 1, 2021. These awards may be earned and become eligible for vesting on May 1, 2021 subject to meeting certain performance conditions and the recipient's continued employment with us - Decrease in travel costs of $5.7 million due to our restriction on non-essential employee travel in response to COVID-19 - Decrease in commissions costs of $1.4 million related to a decrease in commissionable sales 2019 vs. 2018 Sales, marketing and customer success expenses increased by $31.3 million, or 16.2%. The increases in dollars and as a percentage of total revenue were primarily driven by the following: + Increase in compensation costs of $21.2 million primarily associated with our efforts beginning in the second half of 2018 to increase our direct sales force as well as incremental headcount associated with the inclusion of YourCause. As a result, our direct sales headcount increased 8% during 2019. + Increases in allocated corporate costs of $7.0 million primarily driven by investments made in corporate IT, including cyber security and increases in related headcount + Increase in commission expense of $2.2 million primarily driven by an increase in commissionable sales 2020 Form 10-K 41 Table of Contents Blackbaud, Inc. Research and development Research and development expense includes compensation costs for engineering and product management personnel, third-party contractor expenses, software development tools and other expenses related to developing new solutions or upgrading and enhancing existing solutions that do not qualify for capitalization, and allocated depreciation, facilities and IT support costs. 2020 vs. 2019 We continue to make investments to delight our customers with innovative cloud solutions, which is a component of our four-point growth strategy. We also increased engineering hiring during the fourth quarter of 2020. Research and development expenses decreased by $6.0 million, or 5.7%. The decreases in dollars and as a percentage of total revenue were primarily driven by the following: - Decrease in compensation costs of $5.8 million primarily associated with the decision to replace our 2020 cash bonus plans with grants of performance-based equity awards, which are being recognized as stock-based compensation expense between May 1, 2020 and May 1, 2021. These awards may be earned and become eligible for vesting on May 1, 2021 subject to meeting certain performance conditions and the recipient's continued employment with us - Decrease in third-party contractor costs of $1.5 million - Decrease in travel costs of $1.2 million due to our restriction on non-essential employee travel in response to COVID-19 + Partially offset by a decrease in software development costs of $4.5 million that were required to be capitalized under the internal-use software guidance Not included in research and development expense for 2020 and 2019 were $41.5 million and $46.0 million, respectively, of qualifying costs associated with development activities that are required to be capitalized under the internal-use software accounting guidance such as those for our cloud solutions, as well as development costs associated with acquired companies. Qualifying capitalized software development costs associated with our cloud solutions are subsequently amortized to cost of subscriptions revenue over the related asset's estimated useful life, which generally range from three to seven years. We expect that the amount of software development costs capitalized will be relatively consistent in the near-term as we continue making investments in innovation, quality and the integration of our solutions, which we believe will drive long-term revenue growth. 2019 vs. 2018 Research and development expenses increased by $7.4 million, or 7.4%, primarily driven by the following: + Increase in compensation costs of $11.6 million primarily associated with the inclusion of YourCause's engineering resources + Increases in allocations of depreciation, facilities and IT support costs of $3.5 million primarily driven by investments made in corporate IT, including cyber security and increases in related headcount - Partially offset by an increase in software development costs of $9.5 million that were required to be capitalized under the internal-use software guidance Not included in research and development expense for 2019 and 2018 were $46.0 million and $36.5 million, respectively, of qualifying costs associated with development activities that are required to be capitalized under the internal-use software accounting guidance such as those for our cloud solutions, as well as development costs associated with acquired companies. Qualifying capitalized software development costs associated with our cloud solutions are subsequently amortized to cost of subscriptions revenue over the related asset's estimated useful life, which generally range from three to seven years. General and administrative General and administrative expense consists primarily of compensation costs for general corporate functions, including senior management, finance, accounting, legal, human resources and corporate development, third-party professional fees, insurance, allocated depreciation, facilities and IT support costs, acquisition-related expenses and other administrative expenses. 42 2020 Form 10-K Table of Contents Blackbaud, Inc. During the third quarter of 2020, we adjusted our workforce strategy to provide more flexibility for our employees after our offices reopen and we expect to have more employees working remotely either part-time or full time, even within our hub locations. This change is expected to create efficiencies within our real estate footprint as we shift toward more collaborative workspaces within our offices. As a result, during the three months ended September 30, 2020, we reduced the estimated useful lives of our operating lease ROU assets for certain of our office locations we expected to exit, which resulted in an increase in operating lease costs during the third and fourth quarters of 2020. For these same office locations, we also reduced the estimated useful lives of certain facilities-related fixed assets, which resulted in an increase in depreciation expense. We incurred approximately $23.1 million of pre-tax costs related to these real estate activities during the third and fourth quarters of 2020, which we do not expect to recur in 2021. These activities are expected to result in future annual before-tax savings of approximately $14.0 million beginning in 2021. 2020 vs. 2019 General and administrative expenses increased by $21.4 million, or 18.9%. The increases in dollars and as a percentage of total revenue were primarily driven by the following: + Increase in real estate activity costs of $23.1 million due to our workforce strategy changes in response to COVID-19, as discussed above + Increase in corporate costs $5.9 million primarily related to an increase in bad debt expense; for additional details, see Note 2 to our consolidated financial statements in this report - Decrease in rent expense of $4.1 million primarily related to the purchase of our Global Headquarters Facility, see Note 7 to our consolidated financial statements in this report - Decrease in travel costs of $2.4 million due to our restriction on non-essential employee travel in response to COVID-19 - Decrease in compensation costs of $1.8 million primarily related to the decision to replace our 2020 cash bonus plans with grants of performance-based equity awards, which are being recognized as stock-based compensation expense between May 1, 2020 and May 1, 2021. These awards may be earned and become eligible for vesting on May 1, 2021 subject to meeting certain performance conditions and the recipient's continued employment with us 2019 vs. 2018 General and administrative expenses increased by $7.1 million, or 6.6%, primarily driven by the following: + Increase in compensation costs of $13.2 million primarily related to stock-based compensation and our acquisition of YourCause. The increase in stock-based compensation was primarily driven by increases in the grant date fair values of our annual equity awards granted to employees between 2017 and 2019 as our headcount had grown. - Decrease in acquisition-related expenses and integration costs of $3.0 million related to our purchase of YourCause Restructuring During 2017, in an effort to further our organizational objectives including, improved operating efficiency, customer outcomes and employee satisfaction, we initiated a multi-year plan to consolidate and relocate some of our existing offices to highly modern and more collaborative workspaces with short-term financial commitments. We substantially completed our facilities optimization restructuring plan as of December 2019. During the years ended December 31, 2019 and 2018, we incurred $5.8 million and $4.6 million, respectively, in before-tax restructuring charges related to these activities. Such charges during the year ended December 31, 2020 were insignificant. Restructuring costs incurred prior to our adoption of ASU 2016-02 on January 1, 2019 consisted primarily of costs to terminate lease agreements, contractual lease payments, net of estimated sublease income, upon vacating space as part of the plan, as well as insignificant costs to relocate affected employees and write-off facilities-related fixed assets that we would no longer use. Upon adoption of ASU 2016-02 at January 1, 2019, we reduced our operating lease ROU assets recognized at transition by the carrying amounts of the restructuring liabilities for certain leased office spaces that we ceased using prior to December 31, 2018. Restructuring costs incurred during the year ended December 31, 2019 consisted primarily of 2020 Form 10-K 43 Table of Contents Blackbaud, Inc. operating lease ROU asset impairment costs and, to a lesser extent, lease payments for offices we had ceased using and write-offs of facilities-related fixed assets that we would no longer use. Interest Expense Years ended December 31, (dollars in millions) 2020 Change 2019 Change 2018 Interest expense $ 17.3 (16.2) % $ 20.6 29.7 % $ 15.9 % of total revenue 1.9 % 2.3 % 1.9 % 2020 vs. 2019 Interest expense decreased in dollars and as a percentage of revenue during 2020, when compared to 2019, primarily due to a decrease in our average daily borrowings. Our acquisition of YourCause in January 2019 drove the increase in borrowings during 2019 and no business acquisitions were made in 2020. 2019 vs. 2018 Interest expense increased during 2019, when compared to 2018, primarily due to an increase in our average daily borrowings related to our acquisition of YourCause in January 2019. Deferred Revenue The table below compares the components of deferred revenue from our consolidated balance sheets: (dollars in millions) Timing of recognition December 31, 2020 December 31, 2019 Change Recurring Over the period billed in advance, generally one year $ 303.8 $ 302.8 0.4 % One-time services and other As services are delivered 13.1 13.4 (2.3) % Total deferred revenue (1) 316.9 316.1 0.2 % Less: Long-term portion 4.7 1.8 159.6 % Current portion (1) $ 312.2 $ 314.3 (0.7) % (1) The individual amounts for each year may not sum to total deferred revenue or current portion of deferred revenue due to rounding. To the extent that our customers are billed for our solutions and services in advance of delivery, we record such amounts in deferred revenue. 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. We generally invoice our customers with recurring revenue contracts in annual cycles 30 days prior to the end of the contract term. Deferred revenue from recurring revenue contracts as well as one-time services and other were held flat during 2020, primarily due to declines in our 2020 bookings performance compared to our budgeted expectations as a result of COVID-19. We have acquired businesses whose net tangible assets include deferred revenue. In accordance with GAAP reporting requirements, we recorded write-downs of deferred revenue from customer arrangements predating the acquisition to fair value, which resulted in lower recorded deferred revenue as of the acquisition date than the actual amounts paid in advance for solutions and services under those customer arrangements. Therefore, our deferred revenue after an acquisition will not reflect the full amount of deferred revenue that would have been reported if the acquired deferred revenue was not written down to fair value. Further explanation of this impact is included below under the caption "Non-GAAP financial measures". 44 2020 Form 10-K Table of Contents Blackbaud, Inc. Income Taxes Our income tax expense (benefit) and effective income tax rates, including the effects of period-specific events, were: Years ended December 31, (dollars in millions) 2020 2019 2018 Income tax expense (benefit) $ 13.9 $ (1.3) $ (0.2) Effective income tax rate 64.3 % (12.5) % (0.5) % Our effective income tax rate may fluctuate quarterly and annually as a result of factors, including changes in tax law in jurisdictions where we conduct business, transactions entered into, changes in the geographic distribution of our earnings or losses, and our assessment of certain tax contingencies and valuation allowances. We have deferred tax assets for federal, state, and international net operating loss carryforwards and 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. We file income tax returns in the U.S. for federal and various state jurisdictions as well as in foreign jurisdictions including Canada, the U.K., Australia, Ireland and Costa Rica. We are generally subject to U.S. federal income tax examination for calendar tax years ending 2016 through 2020, as well as state and foreign income tax examinations for various years depending on statute of limitations of those jurisdictions. We have taken federal and state tax positions for which it is reasonably possible that the total amount of unrecognized tax benefits may decrease within the next twelve months. The possible decrease could result from the expiration of statutes of limitations. The reasonably possible decrease at December 31, 2020 was $1.1 million. We recognize accrued interest and penalties, if any, related to unrecognized tax benefits as a component of income tax expense. 2020 vs. 2019 The increase in our effective tax rate in 2020 when compared to 2019, was primarily due to increase in valuation allowance attributable to state tax credit carryforwards for which we do not expect to realize benefit. Furthermore, our 2020 effective tax rate was negatively impacted by reduced benefit attributable to research tax credit and stock based compensation deduction. Lastly, higher 2020 earnings lessened impact of other non-deductible items. The total amount of unrecognized tax benefit that, if recognized, would favorably affect the effective income tax rate, was $4.2 million and $3.9 million at December 31, 2020 and December 31, 2019, respectively. 2019 vs. 2018 The decrease in our effective income tax rate in 2019, when compared to 2018, was primarily due to the heightened impact of research credit generation net of Section 162(m) nondeductible compensation. Furthermore, the 2019 effective tax rate was favorably impacted by other state tax credits net of an overall increase to uncertain tax positions. Lastly, the effective tax rate was negatively impacted by Global Intangible Low-Tax Income ("GILTI"), net of Foreign-Derived Intangible Income ("FDII") benefit, resulting from an increase in non-US earnings. The reduced base further magnified the impact of other nondeductible items. Non-GAAP Financial Measures The operating results analyzed below are presented on a non-GAAP basis. We use non-GAAP financial measures internally in analyzing our operational performance. Accordingly, we believe these non-GAAP measures are useful to investors, as a supplement to GAAP measures, in evaluating our ongoing operational performance. While we believe these non-GAAP measures provide useful supplemental information, non-GAAP financial measures should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with GAAP. In addition, these non-GAAP financial measures may not be completely comparable to similarly titled measures of other companies due to potential differences in the exact method of calculation between companies. 2020 Form 10-K 45 Table of Contents Blackbaud, Inc. We have acquired businesses whose net tangible assets include deferred revenue. In accordance with GAAP reporting requirements, we recorded write-downs of deferred revenue under arrangements predating the acquisition to fair value, which resulted in lower recognized revenue than the contributed purchase price until the related obligations to provide services under such arrangements are fulfilled. Therefore, our GAAP revenues after the acquisitions will not reflect the full amount of revenue that would have been reported if the acquired deferred revenue was not written down to fair value. The non-GAAP measures described below reverse the acquisition-related deferred revenue write-downs so that the full amount of revenue booked by the acquired companies is included, which we believe provides a more accurate representation of a revenue run-rate in a given period and, therefore, will provide more meaningful comparative results in future periods. The non-GAAP financial measures discussed below exclude the impact of certain transactions because we believe they are not directly related to our operating performance in any particular period, but are for our long-term benefit over multiple periods. We believe that these non-GAAP financial measures reflect our ongoing business in a manner that allows for meaningful period-to-period comparisons and analysis of trends in our business. Years ended December 31, (dollars in millions) 2020 Change 2019 Change 2018 GAAP Revenue $ 913.2 1.4 % $ 900.4 6.1 % $ 848.6 Non-GAAP adjustments: Add: Acquisition-related deferred revenue write-down — (100.0) % 1.9 (19.8) % 2.4 Non-GAAP revenue (1) $ 913.2 1.2 % $ 902.4 6.0 % $ 851.0 GAAP gross profit $ 485.2 0.7 % $ 482.0 3.2 % $ 466.9 GAAP gross margin 53.1 % 53.5 % 55.0 % Non-GAAP adjustments: Add: Acquisition-related deferred revenue write-down — (100.0) % 1.9 (19.8) % 2.4 Add: Stock-based compensation expense 13.4 297.3 % 3.4 (35.8) % 5.2 Add: Amortization of intangibles from business combinations 39.0 (13.0) % 44.8 6.0 % 42.2 Add: Employee severance 0.9 (25.7) % 1.2 33.0 % 0.9 Subtotal (1) 53.2 3.8 % 51.3 0.9 % 50.8 Non-GAAP gross profit (1) $ 538.4 1.0 % $ 533.3 3.0 % $ 517.7 Non-GAAP gross margin 59.0 % 59.1 % 60.8 % (1) The individual amounts for each year may not sum to non-GAAP revenue, subtotal or non-GAAP gross profit due to rounding. 46 2020 Form 10-K Table of Contents Blackbaud, Inc. Years ended December 31, (dollars in millions, except per share amounts) 2020 Change 2019 Change 2018 GAAP income from operations $ 37.2 37.2 % $ 27.1 (54.3) % $ 59.4 GAAP operating margin 4.1 % 3.0 % 7.0 % Non-GAAP adjustments: Add: Acquisition-related deferred revenue write-down — (100.0) % 1.9 (19.8) % 2.4 Add: Stock-based compensation expense 87.3 48.8 % 58.6 21.5 % 48.3 Add: Amortization of intangibles from business combinations 41.9 (16.4) % 50.1 6.4 % 47.1 Add: Employee severance 4.9 10.2 % 4.4 97.0 % 2.2 Add: Acquisition-related integration costs (0.1) (105.6) % 2.4 (35.0) % 3.7 Add: Acquisition-related expenses 0.4 (69.6) % 1.2 (59.2) % 2.8 Add: Restructuring and other real estate activities 23.3 301.0 % 5.8 26.5 % 4.6 Subtotal (1) 157.5 26.6 % 124.4 12.0 % 111.1 Non-GAAP income from operations (1) $ 194.8 28.5 % $ 151.6 (11.1) % $ 170.5 Non-GAAP operating margin 21.3 % 16.8 % 20.0 % GAAP income before provision for income taxes $ 21.6 104.2 % $ 10.6 (76.3) % $ 44.6 GAAP net income $ 7.7 (35.2) % $ 11.9 (73.4) % $ 44.8 Shares used in computing GAAP diluted earnings per share 48,696,341 0.8 % 48,312,271 0.6 % 48,045,084 GAAP diluted earnings per share $ 0.16 (36.0) % $ 0.25 (73.1) % $ 0.93 Non-GAAP adjustments: Add: GAAP income tax provision (benefit) 13.9 (1,150.4) % (1.3) 504.1 % (0.2) Add: Total Non-GAAP adjustments affecting loss from operations 157.5 26.6 % 124.4 12.0 % 111.1 Non-GAAP income before provision for income taxes 179.1 32.7 % 135.0 (13.3) % 155.7 Assumed non-GAAP income tax provision (2) 35.8 32.7 % 27.0 (13.3) % 31.1 Non-GAAP net income (1) $ 143.3 32.7 % $ 108.0 (13.3) % $ 124.6 Shares used in computing Non-GAAP diluted earnings per share 48,696,341 0.8 % 48,312,271 0.6 % 48,045,084 Non-GAAP diluted earnings per share $ 2.94 31.3 % $ 2.24 (13.5) % $ 2.59 (1) The individual amounts for each year may not sum to subtotal, non-GAAP income from operations, non-GAAP income before provision for income taxes or non-GAAP net income due to rounding. (2) We apply a non-GAAP effective tax rate of 20.0% when calculating non-GAAP net income and non-GAAP diluted earnings per share. 2020 Form 10-K 47 Table of Contents Blackbaud, Inc. Non-GAAP free cash flow Non-GAAP free cash flow is defined as operating cash flow less capital expenditures, including costs required to be capitalized for software development, and capital expenditures for property and equipment. Years ended December 31, (dollars in millions) 2020 Change 2019 Change 2018 GAAP net cash provided by operating activities $ 148.0 (18.9) % $ 182.5 (9.4) % $ 201.4 Less: purchase of property and equipment (29.7) 158.4 % (11.5) (21.9) % (14.7) Less: capitalized software development costs (42.2) (10.1) % (46.9) 24.6 % (37.6) Non-GAAP free cash flow $ 76.1 (38.7) % $ 124.1 (16.7) % $ 149.0 Non-GAAP organic revenue growth In addition, we use non-GAAP organic revenue growth, non-GAAP organic revenue growth on a constant currency basis and non-GAAP organic recurring revenue growth, in analyzing our operating performance. We believe that these non-GAAP measures are useful to investors, as a supplement to GAAP measures, for evaluating the periodic growth of our business on a consistent basis. Each of these measures of non-GAAP organic revenue growth excludes incremental acquisition-related revenue attributable to companies acquired in the current fiscal year. For companies, if any, acquired in the immediately preceding fiscal year, each of these non-GAAP organic revenue growth measures reflects presentation of full year incremental non-GAAP revenue derived from such companies as if they were combined throughout the prior period, and they include the non-GAAP revenue attributable to those companies, as if there were no acquisition-related write-downs of acquired deferred revenue to fair value as required by GAAP. In addition, each of these non-GAAP organic revenue growth measures excludes prior period revenue associated with divested businesses. The exclusion of the prior period revenue is to present the results of the divested businesses within the results of the combined company for the same period of time in both the prior and current periods. We believe this presentation provides a more comparable representation of its current business’ organic revenue growth and revenue run-rate. 48 2020 Form 10-K Table of Contents Blackbaud, Inc. Years ended December 31, (dollars in millions) 2020 2019 GAAP revenue $ 913.2 $ 900.4 GAAP revenue growth 1.4 % (Less) Add: Non-GAAP acquisition-related revenue (1) — 1.9 Non-GAAP organic revenue (2) $ 913.2 $ 902.4 Non-GAAP organic revenue growth 1.2 % Non-GAAP organic revenue (2) 913.2 902.4 Foreign currency impact on Non-GAAP organic revenue (3) 0.8 — Non-GAAP organic revenue on constant currency basis (3) $ 914.0 $ 902.4 Non-GAAP organic revenue growth on constant currency basis 1.3 % GAAP recurring revenue $ 850.7 $ 831.6 GAAP recurring revenue growth 2.3 % (Less) Add: Non-GAAP acquisition-related revenue (1) — 1.9 Non-GAAP organic recurring revenue $ 850.7 $ 833.5 Non-GAAP organic recurring revenue growth 2.1 % (1) Non-GAAP acquisition-related revenue excludes incremental acquisition-related revenue calculated in accordance with GAAP that is attributable to companies acquired in the current fiscal year. For companies acquired in the immediately preceding fiscal year, non-GAAP acquisition-related revenue reflects presentation of full-year incremental non-GAAP revenue derived from such companies, as if they were combined throughout the prior period, and it includes the current period non-GAAP revenue from the acquisition-related deferred revenue write-down attributable to those companies. (2) Non-GAAP organic revenue for the prior year periods presented herein will not agree to non-GAAP organic revenue presented in the respective prior period quarterly financial information solely due to the manner in which non-GAAP organic revenue growth is calculated. (3) To determine non-GAAP organic revenue growth on a constant currency basis, revenues from entities reporting in foreign currencies were translated to U.S. Dollars using the comparable prior period's quarterly weighted average foreign currency exchange rates. The primary foreign currencies creating the impact are the Australian Dollar, British Pound, Canadian Dollar and EURO. 2020 Form 10-K 49 Table of Contents Blackbaud, Inc. Rule of 40 Rule of 40 is defined as non-GAAP organic revenue growth plus non-GAAP adjusted EBITDA margin. Non-GAAP adjusted EBITDA is defined as GAAP net income plus interest, net; income tax provision (benefit); depreciation; amortization of intangible assets from business combinations; amortization of software development costs; acquisition-related deferred revenue write-down; stock-based compensation; acquisition-related integration costs; acquisition-related expenses; employee severance; and restructuring and other real estate activities. Years ended December 31, (dollars in millions) 2020 2019 GAAP net income $ 7.7 $ 11.9 Non-GAAP adjustments: Add: Interest, net 15.6 17.8 Add: GAAP income tax provision (benefit) 13.9 (1.3) Add: Depreciation (1) 14.6 15.0 Add: Amortization of intangibles from business combinations 41.9 50.1 Add: Amortization of software development costs (2) 32.5 21.0 Subtotal 118.5 102.6 Non-GAAP EBITDA $ 126.3 $ 114.5 Non-GAAP EBITDA margin 13.8 % Non-GAAP adjustments: Add: Acquisition-related deferred revenue write-down — 1.9 Add: Stock-based compensation expense 87.3 58.6 Add: Employee severance 4.9 4.4 Add: Acquisition-related integration costs (0.1) 2.4 Add: Acquisition-related expenses 0.4 1.2 Add: Restructuring and other real estate activities 23.3 5.8 Subtotal 115.6 74.4 Adjusted Non-GAAP EBITDA $ 241.9 $ 188.8 Adjusted Non-GAAP EBITDA margin 26.5 % Rule of 40 (3) 27.7 % (1) During th e third quarter of 2020, we reduced the estimated useful lives of our operating lease right-of-use assets for certain of our office locations we expected to exit. For t hese same office locations, we also reduced the estimated useful lives of certain facilities-related fixed assets, which res ulted in an increase in depreciation expense. The accelerated portion of the fixed asset depreciation expense related to these activities of $4.6 million for the year ended December 31, 2020 was presented in the "Restructuring and other real estate activities" line of the reconciliation of GAAP to non-GAAP financial measures. Total depreciation expense for the year ended December 31, 2020 was $19.2 million. (2) Includes amortization expense related to software development costs and amortization expense from capitalized cloud computing implementation costs. (3) Measured by non-GAAP organic revenue growth plus non-GAAP adjusted EBITDA margin. See Non-GAAP organic revenue growth table above. Seasonality Our revenues normally fluctuate as a result of certain seasonal variations in our business. Our transaction revenue has historically been at its lowest in the first quarter due to the timing of customer fundraising initiatives and events. Our revenue from payment services has historically increased during the fourth quarter due to year-end giving. Our revenue from professional services has historically been lower in the first quarter when many of those services commence and in the fourth quarter due to the holiday season. As a result of these and other factors, our total revenue has historically been lower in the first quarter than in the remainder of our fiscal year, with the fourth quarter historically achieving the highest total revenue. Our expenses, however, do not vary significantly as a result of these factors, but do fluctuate on a quarterly basis due to varying timing of expenditures. Our cash flow from operations normally fluctuates quarterly due to the combination of the timing of customer contract renewals including renewals associated with customers of 50 2020 Form 10-K Table of Contents Blackbaud, Inc. acquired companies, delivery of professional services and occurrence of customer events, the payment of bonuses, as well as merit-based salary increases, among other factors. Historically, due to lower revenues in our first quarter, combined with the payment of bonuses from the prior year in our first quarter and the payment of certain annual vendor contracts, our cash flow from operations has been lowest in our first quarter. Due to the timing of customer contract renewals and student enrollments, many of which take place at or near the beginning of our third quarter, our cash flow from operations has been lower in our second quarter as compared to our third and fourth quarters. Partially offsetting these favorable drivers of cash flow from operations in our third and fourth quarters are merit-based salary increases, which have historically been effective in April each year. Annual merit-based salary increases are expected to return in July 2021. In addition, deferred revenues can vary on a seasonal basis for the same reasons. Our cash flow from financing is negatively impacted in our first quarter when most of our equity awards vest, as we pay taxes on behalf of our employees related to the settlement or exercise of equity awards. These patterns may change as a result of the continued shift to online giving, growth in volume of transactions for which we process payments, or as a result of acquisitions, new market opportunities, new solution introductions, the COVID-19 pandemic or other factors. Liquidity and Capital Resources The following table presents selected financial information about our financial position: (dollars in millions) December 31, 2020 December 31, 2019 Change Cash and cash equivalents $ 35.8 $ 31.8 12.4 % Property and equipment, net 105.2 35.5 195.9 % Software development costs, net 111.8 101.3 10.4 % Total carrying value of debt 531.0 467.1 13.7 % Working capital (194.3) (254.3) 23.6 % The following table presents selected financial information about our cash flows: Years ended December 31, (dollars in millions) 2020 Change 2019 Change 2018 Net cash provided by operating activities $ 148.0 (18.9) % $ 182.5 (9.4) % $ 201.4 Net cash used in investing activities (71.8) (57.0) % (167.2) (71.0) % (97.8) Net cash (used in) provided by financing activities (10.7) (109.6) % 111.2 (138.1) % (291.9) Our principal sources of liquidity are operating cash flow, funds available under the 2020 Credit Facility and cash on hand. Our operating cash flow depends on continued customer renewal of our subscription and maintenance arrangements and market acceptance of our solutions and services. Based on current estimates of revenue and expenses, we believe that the currently available sources of funds and anticipated cash flows from operations will be adequate for at least the next twelve months to finance our operations, fund anticipated capital expenditures and meet our debt obligations. To the extent we undertake future material acquisitions, investments or unanticipated capital expenditures, we may require additional capital. In that context, we regularly evaluate opportunities to enhance our capital structure including through potential debt or equity issuances. 2020 Form 10-K 51 Table of Contents Blackbaud, Inc. To better enable us to weather the extraordinary business challenges brought about by the global COVID-19 pandemic, to protect the safety and welfare of our employees, and to further effect our long-term strategy to deliver the greatest value to our stockholders, we have taken several actions. These initial measures taken are expected to provide us the financial flexibility needed to manage a wide array of outcomes that may result from the pandemic. Some of these actions include the following: • Temporarily closed our offices worldwide and transitioned our employees to work remotely; • Rescinded our previously announced policy to pay an annual dividend at a rate of $0.48 per share of common stock and discontinued the declaration and payment of all cash dividends, beginning with the second quarter of 2020 and thereafter until such time, if any, as our Board of Directors may otherwise determine in its sole discretion; • Suspended our 401(k)-match program, whereby we have historically matched 50% of qualified U.S. employees' contributions to our 401(k) plan up to 6% of their salaries, between April 1, 2020 and December 31, 2020; • Made a discretionary matching contribution to eligible employees 401(k) plans in December 2020 totaling $1.2 million, given our financial performance during the fourth quarter; • Temporarily froze our hiring efforts and implemented a modest and targeted headcount reduction, though we have since begun backfilling key roles, including engineering positions; • Michael Gianoni, our President and Chief Executive Officer, elected to forego receipt of all but that portion of his base salary necessary to fund, on a pre-tax basis, his contributions to continue to participate in our health benefits plan, between April 1, 2020 and June 16, 2020; • Restricted non-essential employee travel and put in place other operating cost containment actions; • All of our employees with a base salary equal to or less than $75 thousand received financial support in the form of a one-time bonus of $1 thousand on April 30, 2020; • On May 1, 2020, we granted RSUs to our employees that were eligible for base salary merit increases in lieu of such increases, which will vest on May 1, 2021 subject to the recipient's continued employment with us; • On May 1, 2020, we granted PRSUs to our employees that were eligible for a 2020 cash bonus plan in lieu of such cash bonus, which may be earned and become eligible for vesting on May 1, 2021 subject to meeting certain performance conditions and the recipient's continued employment with us; and • During the third quarter of 2020, we adjusted our workforce strategy to provide more flexibility for our employees to work remotely when our offices reopen. This change also expands our access to a larger and more diverse talent pool, empowers our leaders to make decisions based on skills and business need rather than location, and it is expected to create efficiencies within our real estate strategy as we optimize our footprint and shift toward more collaborative workspaces within our offices. Most of the transactions related to these real estate activities closed during the fourth quarter of 2020 with an aggregate one-time cash outlay of $21.9 million during the third and fourth quarters of 2020. We incurred approximately $23.1 million of pre-tax costs related to these real estate activities during the third and fourth quarters of 2020. These activities are expected to result in future annual before-tax savings of approximately $14.0 million beginning in 2021. In addition to the initial actions we have taken to date, we are continuously evaluating further possible actions in order to respond quickly to rapidly changing conditions, if needed. While we experienced an increase in our aging of receivables during the second and third quarters of 2020 primarily associated with the COVID-19 pandemic, we have seen some improvement in our customers' payment behavior since that time. We have received short-term payment relief requests as a result of COVID-19, most often in the form of payment deferral requests. We are evaluating each request on a case-by-case basis to assess the customer's ability to pay. Not all customer requests ultimately result in modified payment terms, nor are we forgoing our contractual rights under customer agreements. During 2020, our bad debt expense increased by $4.6 million, compared to 2019. We are continually monitoring our customer receivable balances, payment terms, and creditworthiness for changes that could have a significant impact on the collectability of our accounts receivables, our operating results and financial position. At December 31, 2020, our total cash and cash equivalents balance included approximately $18.5 million of cash that was held outside the U.S. While these funds may not be needed to fund our U.S. operations for at least the next twelve months, if we need these funds, we may be required to accrue and pay taxes to repatriate a portion of the funds. We currently do not intend or anticipate a need to repatriate our cash held outside the U.S. 52 2020 Form 10-K Table of Contents Blackbaud, Inc. Operating Cash Flow During 2021, we expect our total operating cash flow to increase when compared to 2020, primarily due to: • the replacement of our 2020 cash bonus plans with performance-based equity awards (which we expect will continue going forward); • the one-time cash payments associated with the exit of a number of our leases in 2020 that will not recur in 2021; and • improvements to working capital management (an expected increase in trade accounts payable); partially offset by • an increase in the payment of payroll taxes as we deferred payments of the employer's portion of Social Security taxes during 2020 under the Coronavirus, Aid, Relief and Economic Security Act ("CARES Act"); • the return of annual merit-based salary increases to our employees in July 2021; and • the return of our 401(k)-match program effective January 1, 2021. Throughout 2020, 2019 and 2018, our cash flows from operations were derived principally from: (i) our earnings from on-going operations prior to non-cash expenses such as depreciation, amortization, stock-based compensation, deferred income taxes, amortization of deferred financing costs and debt discount and adjustments to our provision for credit losses and sales returns; and (ii) changes in our working capital. Working capital changes are comprised of changes in accounts receivable, prepaid expenses and other assets, trade accounts payable, accrued expenses and other liabilities and deferred revenue. 2020 vs. 2019 Net cash provided by operating activities decreased by $34.5 million during the year ended December 31, 2020, when compared to the same period in 2019, primarily due a $81.0 million decrease in cash flow from operations associated with working capital, partially offset by a $46.5 million increase in net income adjusted for non-cash expenses. The decrease in cash flow from operations associated with working capital during 2020, when compared to 2019, was primarily due to: • an increase in current period bonus payments as a result of an increase in amounts accrued as of December 31, 2019 for over-performance against 2019 targets; • a decrease in current period bonus accrual due to our decision to replace cash payments for our 2020 bonus plans with performance-based equity awards; • a decrease in customer billings and payment collections due to the declines in our 2020 bookings performance compared to 2019 as a result of the COVID-19 pandemic; • an increase in the aging of customer receivable balances, primarily due to COVID-19; • an increase in one-time cash payments associated with the exit of a number of our leases; and • fluctuations in the timing of vendor payments. 2019 vs. 2018 Net cash provided by operating activities decreased by $18.9 million during the year ended December 31, 2019, when compared to the same period in 2018, primarily due to a $10.8 million decrease in net income adjusted for non-cash expenses, and a decrease in cash flow from operations associated with working capital. 2020 Form 10-K 53 Table of Contents Blackbaud, Inc. Cash flow from operations associated with working capital decreased $8.1 million during 2019, when compared to 2018, primarily due to: • an increase in the amount of deferred revenue recognized slightly outpacing customer billings; • an increase in collection of customer account balances in 2018 from an aging improvement initiative; and • an income tax refund received in 2018 which did not recur in 2019; partially offset by • an increase in accrued bonuses as of December 31, 2019 when compared the same date in 2018; and • fluctuations in the timing of vendor payments. Investing Cash Flow During 2021, we expect our total capital expenditures to decrease when compared to 2020, primarily due to the purchase of our Global Headquarters Facility in 2020 that will not recur in 2021. 2020 vs. 2019 Net cash used in investing activities of $71.8 million decreased by $95.4 million during 2020, when compared to 2019. We spent $109.4 million for our acquisition of YourCause in 2019 and we did not make any similar investments during 2020. We used $42.2 million for software development costs, which was down $4.7 million from cash spent during 2019. We continue to invest in our innovative cloud solutions, as well as development activities for Blackbaud SKY, our modern cloud platform. We also spent $29.7 million of cash for purchases of property and equipment during 2020, which was up $18.2 million from cash spent in 2019. The additional cash expended was primarily used to purchase our Global Headquarters Facility. 2019 vs. 2018 Net cash used in investing activities of $167.2 million increased by $69.4 million during 2019, when compared to 2018. During 2019, we used net cash of $109.4 million, for our acquisition of YourCause, while we spent $44.9 million on investments in acquired companies in 2018. We used $46.9 million for software development costs, which was up $9.2 million from cash spent during 2018. The increase in cash outlays for software development costs was primarily related to our innovative cloud solutions as well as development activities for Blackbaud SKY, our modern cloud platform. We also spent $11.5 million of cash for purchases of property and equipment during 2019, which was down $3.2 million from cash spent in 2018. The higher cash outlays for property and equipment during 2018 was primarily driven by leasehold improvements for our Global Headquarters Facility. Financing Cash Flow 2020 vs. 2019 During 2020, we had a net increase in borrowings of $0.9 million, compared to a net increase in borrowings of $79.5 million in 2019, which was primarily attributable to our acquisition of YourCause. During 2020, we spent $41.0 million on repurchases of our common stock (see additional details below regarding our stock repurchase program). In addition, during 2020, we paid dividends of $6.0 million, which was down compared to 2019, as we discontinued the declaration and payment of all cash dividends beginning with the second quarter of 2020. We paid $21.4 million to satisfy tax obligations of employees upon settlement or exercise of equity awards during 2020 compared to $23.8 million during 2019. The amount of taxes paid by us on behalf of employees related to the settlement or exercise of equity awards varies from period to period based upon the timing of grants and vesting, employee exercise decisions, as well as the market price for shares of our common stock at the time of settlement. Most of our equity awards currently vest in our first quarter. 54 2020 Form 10-K Table of Contents Blackbaud, Inc. Cash flow from financing activities associated with changes in restricted cash due to customers decreased $16.6 million during 2020, when compared to 2019, as the amount of restricted cash held and payable by us to customers as of December 31, 2019 was significantly larger than at the same date in 2018 primarily due to the timing of year-end donations. Additionally, effective August 3, 2020, a significant amount of restricted cash related to charitable giving transacted through our social responsibility and grantmaking solutions is now held and disbursed by the Blackbaud Giving Fund, an independent nonprofit organization, strategic partner of ours, and sponsoring organization for a donor advised fund. This change was made primarily to better support our YourCause CSR Connect and YourCause Grants Connect solutions. 2019 vs. 2018 During 2019, we had a net increase in borrowings of $79.5 million, which was primarily attributable to our acquisition of YourCause, compared to a net decrease in borrowings of $51.6 million in 2018. We paid $23.8 million to satisfy tax obligations of employees upon settlement or exercise of equity awards during 2019 compared to $27.7 million during 2018. In addition, during 2019, we paid dividends of $23.6 million, which was relatively consistent with 2018. Cash flow from financing activities associated with changes in restricted cash due to customers increased $266.3 million during 2019, when compared to 2018. The amount of restricted cash held and payable by us to customers as of December 31, 2017 was significantly larger than at the same date in 2018 primarily due to the timing of year-end donations. Stock repurchase program In November 2020, our Board of Directors reauthorized and expanded a stock repurchase program that authorizes us to purchase up to $250.0 million of our outstanding shares of common stock. The program does not have an expiration date. Under the stock repurchase program, we are authorized to repurchase shares from time to time in accordance with applicable laws both on the open market, including under trading plans established pursuant to Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, and in privately negotiated transactions. The timing and amount of repurchases depends on several factors, including market and business conditions, the trading price of our common stock and the nature of other investment opportunities. The repurchase program may be limited, suspended or discontinued at any time without prior notice. During the year ended December 31, 2020, we purchased 714,000 shares for $41.0 million. Between January 1, 2021 and February 19, 2021, we repurchased an additional 465,821 shares for $28.1 million. 2020 Credit Facility In October 2020, we entered into a 5-year $900.0 million Amended and Restated Credit Agreement (the “2020 Credit Facility”). Upon closing, we drew $400.0 million on a term loan and used the proceeds to repay the outstanding principal balance of the term loan under the previous credit facility, and repay $124.4 million of outstanding revolving credit loans under the previous credit facility. Historically, we have drawn on our credit facility from time to time to help us meet financial needs primarily due to the seasonality of our cash flows from operations and financing for business acquisitions. At December 31, 2020, our available borrowing capacity under the 2020 Credit Facility was $429.3 million. The 2020 Credit Facility matures in October 2025. At December 31, 2020, the carrying amount of our debt under the 2020 Credit Facility was $467.1 million. Our average daily borrowings were $482.4 million during 2020. Following is a summary of the financial covenants under the 2020 Credit Facility: Financial Covenant Requirement Ratio as of December 31, 2020 Net Leverage Ratio ≤ 4.00 to 1.00 1.75 to 1.00 Interest Coverage Ratio ≥ 2.50 to 1.00 15.95 to 1.00 2020 Form 10-K 55 Table of Contents Blackbaud, Inc. Under the 2020 Credit Facility, we also have restrictions on our ability to declare and pay dividends and our ability to repurchase shares of our common stock. In order to pay any cash dividends and/or repurchase shares of stock: (i) no default or event of default shall have occurred and be continuing under the 2020 Credit Facility, and (ii) our pro forma net leverage ratio, as set forth in the 2020 Credit Facility, must be 0.25 less than the net leverage ratio requirement at the time of dividend declaration or share repurchase. At December 31, 2020, we were in compliance with our debt covenants under the 2020 Credit Facility. Commitments and Contingencies As of December 31, 2020, we had contractual obligations with future minimum commitments as follows: Payments due by period (in millions) Total (1) Less than 1 year 1-3 years 3-5 years More than 5 years Recorded contractual obligations: Debt (2) $ 534.2 $ 12.8 $ 25.0 $ 443.0 $ 53.4 Operating leases (3) 29.5 10.4 10.2 5.1 3.8 Interest payments on debt (4) 4.5 3.4 1.1 — — Unrecorded contractual obligations: Purchase obligations (5) 94.8 59.1 34.6 1.0 — Interest payments on debt (6) 79.5 11.5 23.4 21.0 23.6 Total contractual obligations (1) $ 742.5 $ 97.2 $ 94.3 $ 470.2 $ 80.8 (1) The individual amounts for each obligation may not sum to total or total contractual obligations due to rounding. (2) Represents principal payments only, under the following assumptions: (i) that the amounts outstanding under the 2020 Credit Facility, our real estate loans and our other debt at December 31, 2020 will remain outstanding until maturity, with minimum payments occurring as currently scheduled, and (ii) that there are no assumed future borrowings on the 2020 Revolving Facility for the purposes of determining minimum commitment amounts. (3) Our commitments related to operating leases have not been reduced by sublease income, incentive payments, reimbursement of leasehold improvements and the amount representing imputed interest of $2.8 million. (4) Represents interest payment obligations related to our interest rate swap agreements. (5) 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. (6) The actual interest expense recognized in our consolidated statements of comprehensive income will depend on the amount of debt, the length of time the debt is outstanding and the interest rate, which could be different from our assumptions described in (2) above. The term loan under the 2020 Credit Facility and our other debt 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 2020 Credit Facility in October 2025. The Real Estate Loans also require periodic principal payments and the balance of the real estate loans are due upon maturity in April 2038. The total liability for uncertain tax positions as of December 31, 2020 and December 31, 2019, was $4.6 million and $4.3 million, respectively. Our accrued interest and penalties related to tax positions taken on our tax returns was $1.1 million and $1.0 million as of December 31, 2020 and 2019, respectively. Off-Balance Sheet Arrangements As of December 31, 2020, we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K promulgated by the SEC, that have or are reasonably likely to have, a current or future effect on our financial condition, changes in our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. 56 2020 Form 10-K Table of Contents Blackbaud, Inc. Foreign Currency Exchange Rates Approximately 15% of our total revenue for 2020 was generated by operations outside the U.S. We do not have significant operations in countries in which the economy is considered to be highly inflationary. Our consolidated financial statements are denominated in U.S. dollars and, accordingly, changes in the exchange rate between foreign currencies and the U.S. dollar will affect the translation of our subsidiaries’ financial results into U.S. dollars for purposes of reporting our consolidated financial results. The accumulated currency translation adjustment, recorded within other comprehensive loss as a component of stockholders’ equity, was a gain of $0.6 million as of December 31, 2020 and a loss of $4.0 million as of December 31, 2019. The vast majority of our contracts are entered into by our U.S. or U.K. entities. The contracts entered into by the U.S. entity are almost always denominated in U.S. dollars or Canadian dollars, and contracts entered into by our U.K., Australian and Irish subsidiaries are generally denominated in British Pounds, Australian dollars and Euros, respectively. Historically, as the U.S. dollar weakened, foreign currency translation resulted in an increase in our revenues and expenses denominated in non-U.S. currencies. Conversely, as the U.S. dollar strengthened, foreign currency translation resulted in a decrease in our revenues and expenses denominated in non-U.S. currencies. During 2020, foreign translation resulted in decreases in our revenues and expenses denominated in non-U.S. currencies. Though we have exposure to fluctuations in currency exchange rates, the impact has generally not been material to our consolidated results of operations or financial position. During 2020, the fluctuation in foreign currency exchange rates reduced our total revenue and our income from operations by $0.8 million and $0.7 million, respectively. We will continue monitoring such exposure and take action as appropriate. To determine the impacts on revenue (or income from operations) from fluctuations in currency exchange rates, current period revenues (or income from operations) from entities reporting in foreign currencies were translated into U.S. dollars using the comparable prior year period's weighted average foreign currency exchange rates. These impacts are non-GAAP financial information and are not in accordance with, or an alternative to, information prepared in accordance with GAAP. Inflation We do not believe that inflation has had a material effect on our business, financial condition or results of operations. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations. In addition, if inflationary pressures impact the rate of giving to our customers, there could be adverse impacts to our business, financial condition and results of operations. Critical Accounting Estimates Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. On an ongoing basis, we reconsider and evaluate our estimates and assumptions. We base our estimates on historical experience, current trends and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could materially differ from any of our estimates under different assumptions or conditions. Our significant accounting policies are discussed in Note 2 to our consolidated financial statements in this report. We believe the accounting estimates listed below are the most critical to aid in fully understanding and evaluating our reported financial results, and they require our most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. 2020 Form 10-K 57 Table of Contents Blackbaud, Inc. Revenue Recognition Description Judgments and Uncertainties Effect if Actual Results Differ From Assumptions See Note 2 to our consolidated financial statements in this report for a complete discussion of our revenue recognition policies. Revenues are recognized when control of our 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: (1) Identification of the contract, or contracts, with a customer; (2) Identification of the performance obligations in the contract; (3) Determination of the transaction price; (4) Allocation of the transaction price to the performance obligations in the contract; and (5) Recognition of revenue when, or as, we satisfy a performance obligation. Our revenue recognition accounting methodology contains uncertainties because it requires us to make significant estimates and assumptions, and to apply judgment. For example, for arrangements that have multiple performance obligations, we must exercise judgment and use estimates in order to (1) determine whether performance obligations are distinct and should be accounted for separately; (2) determine the standalone selling price of each performance obligation; (3) allocate the transaction price among the various performance obligations on a relative standalone selling price basis; and (4) determine whether revenue for each performance obligation should be recognized at a point in time or over time. In addition, we exercise judgment in certain transactions when determining whether we should recognize revenue based on the gross amount billed to a customer (as a principal) or the net amount retained (as an agent). These judgments are based on our determination of whether or not we control the service before it is transferred to the customer. If we were to change any of these judgments or estimates, it could cause a material increase or decrease in the amount of revenue or deferred revenue that we report in a particular period. Costs of Obtaining Contracts Description Judgments and Uncertainties Effect if Actual Results Differ From Assumptions 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 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. Our accounting methodology for determining the period over which we amortize costs of obtaining contracts with customers contains uncertainties because it requires us to make significant estimates and assumptions, and to apply judgment. For example, we must exercise judgment and use estimates in order to determine the expected period of benefit of our sales commissions. We take into consideration our customer contracts, including renewals, retention, our technology and other factors. If we were to change any of these judgments or estimates, it could cause a material increase or decrease in the amount of assets, operating expenses or income that we report in a particular period. 58 2020 Form 10-K Table of Contents Blackbaud, Inc. Business Combinations Description Judgments and Uncertainties Effect if Actual Results Differ From Assumptions We allocate the purchase price of an acquired business to its identifiable assets acquired and liabilities assumed at the acquisition date based upon their estimated fair values. The excess of the purchase price over the amount allocated to the identifiable assets acquired and liabilities assumed, if any, is recorded as goodwill. We use available information to estimate fair values. We typically engage outside appraisal firms to assist in the fair value determination of long-lived and identifiable intangible assets, and any other significant assets or liabilities. We adjust the preliminary purchase price allocation, as necessary, up to one year after the acquisition closing date as we obtain new information about facts and circumstances that existed as of the closing date. Our purchase price allocation methodology contains uncertainties because it requires us to make significant estimates and assumptions, and to apply judgment to estimate the fair value of assets acquired and liabilities assumed, especially with respect to long-lived and intangible assets. Management estimates the fair value of assets acquired and liabilities assumed based on quoted market prices, the carrying value of the acquired assets and widely accepted valuation techniques, including discounted cash flows and market multiple analyses. Critical estimates in valuing intangible assets include, but are not limited to, estimates about: expected future cash flows from customers, including revenue and operating expenses; royalty and customer attrition rates; proprietary technology obsolescence curve; the acquired company's brand awareness and market position; the market awareness of the acquired company's branded technology solutions and services; assumptions about the period of time the brands will continue to be valuable; as well as expected costs to develop any in-process research and development into commercially viable solutions and estimated cash flows from the projects when completed, and discount rates. Our estimates of fair value are based upon assumptions we believe to be reasonable, but which are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur. If actual results are materially different than the assumptions we used to determine fair value of the assets acquired and liabilities assumed through a business combination as well as the estimated useful lives of the acquired intangible assets, it is possible that adjustments to the carrying values of such assets and liabilities will have a material impact on our financial position and results of operations. See Note 3 to our consolidated financial statements in this report for information regarding our business acquisitions. Income Taxes Description Judgments and Uncertainties Effect if Actual Results Differ From Assumptions We make estimates and judgments in accounting for income taxes. Our income tax returns, like those of most companies, are periodically audited by domestic and foreign tax authorities. We measure and recognize uncertain tax positions. To recognize uncertain tax positions, we must first determine if it is more likely than not that the position will be sustained upon audit. We must then measure the benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement. We make estimates in determining tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial reporting purposes. We record valuation allowances to reduce our deferred tax assets to the amount expected to be realized. The calculation of our income tax provision requires estimates due to transactions, credits and calculations where the ultimate tax determination is uncertain. Uncertainties arise as a consequence of the actual source of taxable income between domestic and foreign locations, the outcome of tax audits and the ultimate utilization of tax credits. Our effective income tax rate is also affected by changes in the geographic distribution of our earnings or losses, changes in tax law in jurisdictions where we conduct business. Significant judgment is required in the identification and measurement of uncertain tax positions. Our liability for unrecognized tax benefits contains uncertainties because management is required to make assumptions and to apply judgment to estimate the exposures associated with our various filing positions. In assessing the adequacy of a recorded valuation allowance significant judgment is required. We consider all positive and negative evidence and a variety of factors including the scheduled reversal of deferred tax liabilities, historical and projected future taxable income, and prudent and feasible tax planning strategies. Although we believe that the judgments and estimates discussed herein are reasonable, actual results could differ, and we may be exposed to losses or gains that could be material. To the extent actual results differ from estimated amounts recorded, such differences will impact the income tax provision in the period in which the determination is made. If we determine there is less than a 50% likelihood that we will be able to use a deferred tax asset in the future in excess of its net carrying value, then an adjustment to the deferred tax asset valuation allowance is made to increase income tax expense, thereby reducing net income in the period such determination was made. 2020 Form 10-K 59 Table of Contents Blackbaud, Inc. Long-lived Assets and Intangible Assets Other Than Goodwill Description Judgments and Uncertainties Effect if Actual Results Differ From Assumptions We review our long-lived assets and intangible assets other than goodwill for impairment when events or changes in circumstances indicate the carrying amount may not be recoverable. If such events or changes in circumstances occur, we use the undiscounted cash flow method to determine whether our long-lived and intangible assets other than goodwill are impaired. To the extent that the carrying value of the asset exceeds the undiscounted cash flows over the estimated remaining life of the asset, we measure the impairment using discounted cash flows. When measuring impairment of an asset using discounted cash flows, we make assumptions and apply judgment in estimating future cash flows and asset fair values, including annual revenue growth rates, a terminal year growth rate and selecting a discount rate that reflects the risk inherent in future cash flows. We have not made any material changes in the accounting methodology we use to assess impairment loss during the year ended December 31, 2020. During 2020, we recorded impairment charges against certain property and equipment assets and certain operating lease ROU assets. For additional information, see Notes 7 and 11 to our consolidated financial statements in this report. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to assess impairment losses. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to an impairment charge that could materially adversely impact our consolidated financial position and results of operations. Recently Issued Accounting Pronouncements For a discussion of the impact that recently issued accounting pronouncements are expected to have on our financial position and results of operations when adopted in the future, see Note 2 to our consolidated financial statements in this report. 60 2020 Form 10-K Table of Contents Blackbaud, Inc.