BLACKBAUD INC 10-Q

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited, condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. The following discussion and analysis presents financial information denominated in millions of dollars which can lead to differences from rounding when compared to similar information contained in the unaudited, condensed consolidated financial statements and related notes which are primarily denominated in thousands of dollars. Executive Summary We are the world’s leading cloud software company powering social good. Serving the entire social good community—nonprofits, higher education institutions, K–12 schools, healthcare organizations, faith communities, arts and cultural organizations, foundations, companies and individual change agents—we connect and empower organizations to increase their impact through cloud software, services, expertise and data intelligence. Our portfolio is tailored to the unique needs of vertical markets, with solutions for fundraising and CRM, marketing, advocacy, peer-to-peer fundraising, corporate social responsibility (CSR) and environmental, social and governance (ESG), school management, ticketing, grantmaking, financial management, payment processing and analytics. Serving the industry for more than four decades, we are a remote-first company headquartered in Charleston, South Carolina, with operations in the United States, Australia, Canada, Costa Rica and the United Kingdom. Our revenue is primarily generated from the following sources: (i) charging for the use of our software solutions in cloud and hosted environments; (ii) providing payment and transactional services; (iii) providing software maintenance and support services; (iv) providing Impact-as-a-Service ™ digital educational content; and (v) providing professional services, including implementation, consulting, training, analytic and other services. COVID-19 Impact The economic impact of COVID-19 on the social good industry remains somewhat uncertain, although we are seeing signs of recovery in the industry. Our end markets continue to display resilience in the post-pandemic recovery with a digital-first mindset. In February 2022, the Blackbaud Institute released its annual Charitable Giving Report, which reported that overall giving in 2021 grew 9% with the percent of giving done online up significantly from pre-pandemic levels and holding steady in the low-teens. Nearly 30% of those online donations are being made on a mobile device, which we see as a long-term positive as we equip organizations to process mobile donations and optimize mobile user interfaces. If our existing and prospective customers remain cautious in their purchase decisions, our operating environment may continue to be challenging. Notwithstanding these conditions, we remain focused on continuing to execute our four-point strategy and strengthening our leadership position. Four-Point Strategy 1 Expand Total Addressable Market 2 Lead with World Class Teams and Operations 3 Delight Customers with Innovative Cloud Solutions 4 Focus on Employees, Culture and ESG Initiatives 1. Expand Total Addressable Market ("TAM") In December 2021, we doubled our TAM when we acquired EVERFI, an industry leader in global social impact technology. Adding EVERFI advances our position as a leader in the rapidly evolving ESG and CSR spaces and offers cross-selling and upselling opportunities through complementary product offerings with YourCause® solutions. Our TAM now stands at over $20 billion, and we remain active in the evaluation of opportunities to further expand our addressable market through acquisitions and internal product development. 26 Third Quarter 2022 Form 10-Q Table of Contents Blackbaud, Inc. (Unaudited) 2. Lead with World Class Teams and Operations This strategy expands upon our previous strategies to drive sales effectiveness and improve operating efficiency to include improving overall company performance as measured by the Rule of 40 (see discussion of Non-GAAP Financial Measures below). Recently, we announced a series of strategic organizational updates to streamline our business operations and become even more customer centric. We created three new roles: Chief Operating Officer, Chief Commercial Officer and Executive Vice President of Corporations. We believe these new roles will: ensure consistency in our approach to the customer experience; further streamline and simplify our go-to-market efforts to maximize our outcomes as a global company; and further align our YourCause and EVERFI offerings and continue our investment in being the partner of choice for corporations focused on social responsibility and impact. Additionally, we recently took steps to better align our workforce with our strategic priorities, including further elimination of open positions as well as the difficult decision to reduce our workforce (see additional discussion regarding our workforce reduction below). We also appointed a new member to our board of directors, who brings over 20 years of experience in technology and cybersecurity to our board. 3. Delight Customers with Innovative Cloud Solutions During our recent annual user conference, bbcon, we shared how our purpose-built solutions bring together the capabilities essential to our customers in managing their data, making their teams more productive, motivating their audiences to act, and ultimately driving outcomes. During the third quarter, we also acquired Kilter, an intuitive, gamified, activity-based engagement app. We will initially pair Kilter with our Blackbaud TeamRaiser solution to serve nonprofits by expanding the ways they can engage with their supporters to prepare for their existing fundraising walks, runs and rides, and to create new types of engagement opportunities that are not tied to a specific date or place. Kilter will also provide a unique solution with YourCause CSRConnect platform for companies as employers take a more active role in supporting their employees’ health and wellness pursuits across their remote and distributed workforces. 4. Focus on Employees, Culture and ESG Initiatives We recently announced that we achieved carbon neutrality for 2021. This is a goal we have been striving towards and our shift to a remote-first workforce enabled us to accelerate our timeline. Since 2019, Blackbaud has reduced its global real estate footprint by 50%, energy emissions to run office space by 63% and employee commute emissions by 75%. With a multi-pronged climate strategy, Blackbaud is focused on reducing emissions, using energy efficiently and investing in environmental projects for a more sustainable future. We shared more about our ESG strategy on our Corporate Social Responsibility website during the second quarter. Our mission driven culture has been in our DNA since inception and is very attractive in a competitive labor market. We continue to foster a diverse and inclusive environment focused on employee engagement and connectedness with our remote-first workforce strategy. We have a significant role to play in driving advances in the social good space, and we are proud of the strong corporate culture we have built and continue to cultivate in today's environment. Third Quarter 2022 Form 10-Q 27 Table of Contents Blackbaud, Inc. (Unaudited) Financial Summary Total revenue ($M) Income from operations ($M) YoY Growth (%) YoY Growth (%) Total revenue increased by $30.1 million and $103.5 million during the three and nine months ended September 30, 2022, respectively, when compared to the same periods in 2021, driven largely by the following: + Growth in recurring revenue primarily related to: • increases in contractual recurring revenue of $27.7 million and $81.6 million, respectively, related to the performance of our cloud solutions, of which $23.7 million and $71.2 million, respectively, was attributable to EVERFI; partially offset by decreases in maintenance revenue as customers migrate to our cloud solutions and decreases related to fluctuations in foreign currency exchange rates of $1.3 million and $2.3 million, respectively; and • increases in transactional recurring revenue of $3.2 million and $22.7 million, respectively, primarily due to an increase in online charitable giving, an increase in enrollment for our Blackbaud Tuition Management solution resulting in a higher transactional volumes and, to a lesser extent, increased transactional volume as our customer's constituents have begun to return to in-person events. These increases in transactional recurring revenue were partially offset by decreases related to fluctuations in foreign currency exchange rates of $3.1 million and $5.5 million, respectively. - Decreases in one-time service and other revenue primarily related to: • decreases in one-time analytics revenue as analytics are generally integrated in our cloud solutions; partially offset by • increases in one-time consulting revenue due primarily to our acquisition of EVERFI, largely offset by a decrease in implementation and customization services, in line with our multi-year strategic shift from a license-based and one-time services business model to a cloud subscription business model. Our cloud subscription offerings generally require less implementation and customization services. 28 Third Quarter 2022 Form 10-Q Table of Contents Blackbaud, Inc. (Unaudited) We currently expect that fluctuations in foreign currency exchange rates will have a significant negative impact on our total revenue for the full year 2022. While our year-to-date bookings for EVERFI continue to be lighter than expected, we have taken action to bolster management and fill account executive vacancies, which are now fully staffed and ramping to drive future bookings. Additionally, we currently expect one-time services and other revenue to modestly decrease during 2022 when compared to 2021, inclusive of incremental one-time revenue expected from EVERFI. We have a number of multi-year pricing initiatives underway, some to bring our pricing in line with the market while others are model changes that are expected to drive greater revenue for both us and our customers. For additional information on the impact of foreign currency fluctuations on our financial results, see Foreign Currency Exchange Rates below on page 47 . Income from operations decreased by $18.9 million and $44.5 million during the three and nine months ended September 30, 2022, respectively, when compared to the same periods in 2021, driven largely by the following: - Increases in compensation costs other than stock-based compensation of $20.7 million and $61.5 million, respectively, primarily due to increased employee headcount due to our acquisition of EVERFI - Increases in third-party contractor costs of $6.8 million and $21.6 million, respectively, and hosting costs of $1.0 million and $5.5 million, respectively, primarily attributable to our acquisition of EVERFI and, to a lesser extent, our continued migration of our cloud infrastructure to leading public cloud service providers and investments in cybersecurity - Increases in Security Incident-related expenses, net of insurance, of $12.8 million and $27.9 million, respectively. See "Security Incident update" below. - Increases in transaction-based costs of $2.9 million and $12.2 million, respectively, related to the increase in the volume of transactions for which we process payments - Increases in amortization of intangible assets from business combinations of $3.4 million and $10.8 million, respectively, due to our acquisition of EVERFI - Increases in infrastructure costs of $1.6 million and $5.8 million, respectively, primarily related to our acquisition of EVERFI and investments in security tools - Increases in acquisition and disposition-related costs of $2.4 million and $5.6 million, respectively, primarily related to a $2.0 million noncash impairment of certain insignificant intangible assets held for sale - Increases in marketing costs of $1.1 million and $5.0 million, respectively, primarily due to our acquisition of EVERFI - Increases in travel costs of $1.1 million and $3.7 million, respectively, due to our easing of restrictions on non-essential employee travel, which went into effect during March 2020 in response to the COVID-19 pandemic - A $2.3 million noncash impairment charge during the nine months ended September 30, 2022, against previously capitalized software development costs that reduced the carrying value of those assets to zero. The impairment charge resulted primarily from our decision to end customer support for certain solutions + Increases in total revenue, as described above + Decreases in stock-based compensation expense of $1.0 million and $5.8 million, respectively, attributable to: • A decrease in the grant date fair value of our annual equity awards granted to employees during 2022 compared to 2021; and • As a one-time response to COVID-19, replacement of our 2020 base salary merit increases with one-year time-based equity awards, which vested and were recognized as expense between May 1, 2020 and May 1, 2021. We are continuing to make critical investments in the business in areas such as digital marketing, innovation, cybersecurity, customer success and our continued shift of cloud infrastructure to leading public cloud service providers. Our profitability through the third quarter reflects the addition of EVERFI and some of these incremental investments. We have taken steps to better align our workforce with our strategic priorities to drive efficiencies and minimize any potential impacts from the current uncertain macroeconomic environment. This recently included further elimination of open positions as well as the decision to reduce our workforce. As a result of the workforce targeted reduction, we expect to incur between $6 million and $8 million in pre-tax employee severance costs primarily during the fourth quarter of 2022. We expect this workforce reduction and other cost actions will reduce our planned future pre-tax cost run rate by approximately $40 million Third Quarter 2022 Form 10-Q 29 Table of Contents Blackbaud, Inc. (Unaudited) to $50 million beginning in 2023, partially offset by continued investments in cybersecurity and innovation. We see further opportunity in 2023 and beyond to scale our infrastructure costs, reduce overhead and execute pricing initiatives. We continuously seek opportunities to optimize our portfolio of solutions to focus time and resources on innovation that will have the greatest impact for our customers and the markets we serve, and drive the highest return on investment. To that end, we will continue to simplify and rationalize our portfolio through product sunsets and divestitures of non-core businesses and technologies. 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 recurring service customer contracts provides a better representation of our customers' overall behavior. For the twelve months ended September 30, 2022, approximately 91% of our customers with recurring revenue contracts were retained. This customer retention rate decreased from our rate for the full year ended December 31, 2021 and reflects our continuing efforts to rationalize our portfolio of solutions and migrate customers from legacy solutions towards our next generation solutions. Balance sheet and cash flow At September 30, 2022, our cash and cash equivalents were $31.4 million and the carrying amount of our debt under the 2020 Credit Facility was $795.5 million. Our net leverage ratio was 3.10 to 1.00. During the nine months ended September 30, 2022, we generated $189.8 million in cash from operations, had a net decrease in borrowings of $102.5 million, had aggregate cash outlays of $53.3 million for purchases of property and equipment and capitalized software and content development costs, and spent $20.9 million for our purchases of EVERFI and Kilter. Security Incident update As discussed in Note 10 to our unaudited, condensed consolidated financial statements included in this report, t otal costs related to the Security Incident have exceeded the limit of our insurance coverage . Accordingly, we expect that the Security Incident will continue to negatively impact our GAAP profitab ility and GAAP cash flow for the foreseeable future (see discussion regarding our non-GAAP financial measures beginning on page 38 ). Fo r full year 2022, we currently expect net pre-tax expense of approximately $30 million to $35 million for ongoing legal fees related to the Security Incident. In line with our policy, legal fees are expensed as incurred. For full year 2022, we currently expect net cash outlays of approximately $15 million to $25 million for ongoing legal fees related to the Security Incident. As of September 30, 2022, we have recorded approximately $5.0 million in aggregate liabilities for a loss contingencies related to the Security Incident that we believe we can reasonably estimate. Certain of these recorded charges reflect the low end of a range of estimated losses based on our determination that no estimate within that range was better than any other amount. It is reasonably possible that actual losses in the future for those matters will be in excess of the amounts accrued, but we are unable at this time to reasonably estimate the possible additional loss. There are other Security Incident-related matters, including customer claims, customer constituent class actions and governmental investigations, for which we have not recorded a liability for a loss contingency as of September 30, 2022 because we are unable at this time to reasonably estimate the possible loss or range of loss. 30 Third Quarter 2022 Form 10-Q Table of Contents Blackbaud, Inc. (Unaudited) Results of Operations Comparison of the three and nine months ended September 30, 2022 and 2021 We have included the results of operations of acquired companies in our consolidated results of operations from the date of their respective acquisition. We determined that the EVERFI and Kilter acquisitions were not material to our consolidated financial statements; therefore, separate presentation of revenue and earnings since the acquisition date is not required. Revenue and Cost of Revenue Recurring Revenue ($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, Impact-as-a-Service ™ digital educational content, hosting services, payment services, online training programs, subscription-based analytic 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. Third Quarter 2022 Form 10-Q 31 Table of Contents Blackbaud, Inc. (Unaudited) Our customers continue to prefer cloud subscription offerings with integrated analytics, training and payment services. Recurring subscription contracts are typically for a term of three years at contract inception with one to three-year renewals thereafter. We intend to continue focusing on innovation, quality and integration of our cloud solutions, which we believe will drive future revenue growth. Recurring revenue increased by $30.9 million, or 14.1%, and $104.3 million, or 16.2%, during the three and nine months ended September 30, 2022, respectively, when compared to the same periods in 2021, driven primarily by the following: + Increases in contractual recurring revenue of $27.7 million and $81.6 million, respectively, related to the performance of our cloud solutions, of which $23.7 million and $71.2 million, respectively, was attributable to EVERFI; partially offset by decreases in maintenance revenue as customers migrate to our cloud solutions; also offsetting the increases in contractual recurring revenue were decreases related to fluctuations in foreign currency exchange rates of $1.3 million and $2.3 million, respectively + Increase in transactional recurring revenue of $3.2 million for the three months ended, September 30, 2022, primarily due to an increase in enrollment for our Blackbaud Tuition Management solution resulting in higher transactional volumes. The increase in transactional recurring revenue during the three months ended September 30, 2022, was partially offset by a decrease related to fluctuations in foreign currency exchange rates of $3.1 million + Increase in transactional recurring revenue of $22.7 million for the nine months ended September 30, 2022, primarily due to: • an increase in online charitable giving; • an increase in enrollment for our Blackbaud Tuition Management solution resulting in a higher transactional volumes; and • to a lesser extent, increased transactional volume as our customer's constituents have begun to return to in-person events. The increase in transactional recurring revenue during the nine months ended September 30, 2022, was partially offset by a decrease related to fluctuations in foreign currency exchange rates of $5.5 million For additional information on the impact of foreign currency fluctuations on our financial results, see Foreign Currency Exchange Rates below on page 47 . Cost of recurring revenue increased by $15.7 million, or 16.3%, and $59.0 million, or 21.1%, during the three and nine months ended September 30, 2022, respectively, when compared to the same periods in 2021, driven primarily by the following: + Increases in compensation costs of $4.6 million and $17.4 million, respectively, primarily related to an increase in headcount due to our acquisition of EVERFI, and a continued shift in resources historically supporting one-time services and other towards recurring revenue + Increases in transaction-based costs of $2.9 million and $12.1 million, respectively, related to the increase in the volume of transactions for which we process payments + Increases in amortization of intangible assets from business combinations of $3.4 million and $10.5 million, respectively, due to our acquisition of EVERFI + Increase in third-party contractor and hosting costs of $7.5 million for the nine months ended September 30, 2022 as we continue to migrate our cloud infrastructure to leading public cloud service providers and make investments in security; currently, we expect our cloud infrastructure migration efforts and increased level of cybersecurity investments to continue for the foreseeable future + Increases in amortization of software development costs of $1.8 million and $4.1 million, respectively, due to our continued investments in the innovation and security of our solutions + Increase in allocated overhead costs of $3.2 million for the nine months ended September 30, 2022 related to the increased headcount discussed above Recurring gross margin decreased by 0.9% and 1.8% for the three and nine months ended September 30, 2022, respectively, when compared to the same periods in 2021, primarily due to the increase in cost of recurring revenue outpacing the increase in recurring revenue. 32 Third Quarter 2022 Form 10-Q Table of Contents Blackbaud, Inc. (Unaudited) One-time services and other Revenue ($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, 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, allocated depreciation, facilities and IT support costs and amortization of intangible assets from business combinations. One-time services and other revenue decreased by $0.8 million, or 6.1%, and $0.8 million, or 2.1%, during the three and nine months ended September 30, 2022, when compared to the same periods in 2021, driven primarily by the following: - Decreases in one-time analytics revenue of $0.5 million and $2.2 million, respectively, as analytics are generally integrated in our cloud solutions + Increases in one-time consulting revenue of $0.2 million and $1.9 million, respectively, primarily attributable to EVERFI, largely offset by less revenue from implementation and customization services, in line with our multi-year strategic shift from a license-based and one-time services business model to a cloud subscription business model. Our cloud subscription offerings generally require less implementation and customization services. Third Quarter 2022 Form 10-Q 33 Table of Contents Blackbaud, Inc. (Unaudited) Cost of one-time services and other decreased by $2.4 million, or 20.3%, and $8.3 million, or 20.6%, during the three and nine months ended September 30, 2022, respectively, when compared to the same periods in 2021, driven primarily by the following: - Decreases in compensation costs of $1.4 million and $6.7 million, respectively, largely due to a continued shift in resources historically supporting one-time services and other towards recurring revenue as well as a decrease in professional services headcount - Decrease in allocated overhead costs of $1.4 million for the nine months ended September 30, 2022, primarily related to the decreased headcount discussed above One-time services and other gross margin increased by 14.1% and 20.1% during the three and nine months ended September 30, 2022, respectively, when compared to the same periods in 2021, primarily due to the significant reductions in compensation costs discussed above. Operating Expenses Sales, marketing and customer success ($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. We have also implemented software tools to enhance our digital footprint and drive lead generation. The enhancements we are making in our go-to-market approach are expected to significantly reduce our average customer acquisition cost per customer as well as the related payback period while increasing sales velocity. 34 Third Quarter 2022 Form 10-Q Table of Contents Blackbaud, Inc. (Unaudited) Sales, marketing and customer success expense increased by $11.7 million, or 26.2%, and $25.4 million, or 18.3%, during the three and nine months ended September 30, 2022, respectively, when compared to the same periods in 2021, primarily driven by the following: + Increases in compensation costs of $6.9 million and $14.6 million, respectively, primarily related to increased employee headcount due to our acquisition of EVERFI + Increases in third-party contractor costs of $2.5 million and $3.4 million, respectively, primarily related to strategic consulting + Increases in advertising costs of $1.1 million and $5.0 million, respectively, primarily due to our acquisition of EVERFI + Increase in travel costs of $1.6 million for the nine months ended September 30, 2022 due to our easing of restrictions on non-essential employee travel, which went into effect during March 2020 in response to the COVID-19 pandemic + Increase in software costs of $1.3 million for the nine months ended September 30, 2022 primarily related to our acquisition of EVERFI and our use of digital marketing tools Research and development Research and development expense includes compensation costs for engineering and product management personnel, third-party contractor expenses, software development tools and other expenses related to developing new solutions or upgrading and enhancing existing solutions that do not qualify for capitalization, and allocated depreciation, facilities and IT support costs. We continue to make investments to delight our customers with innovative and secure cloud solutions. Research and development expenses increased by $8.9 million, or 28.1%, and $27.8 million or 30.5%, during the three and nine months ended September 30, 2022, respectively, when compared to the same periods in 2021, primarily driven by the following: + Increases in compensation costs of $7.9 million and $22.0 million, respectively, primarily related to increased employee headcount due to our acquisition of EVERFI, and to a lesser extent, our increased hiring of engineers + Increases in third-party contractor costs of $5.0 million and $16.0 million, respectively, primarily due to our acquisition of EVERFI and, to a lesser extent, an increase in our use of third-party software developers + Increase in allocated overhead costs of $2.1 million for the nine months ended September 30, 2022, primarily related to increased headcount discussed above - Increases in software development costs of $5.4 million and $14.5 million, respectively, that were required to be capitalized under GAAP, of which $5.2 million and $9.3 million was attributable to EVERFI software and content Not included in research and development expense for the three months ended September 30, 2022 and 2021 were $15.1 million and $9.7 million, respectively, and for the nine months ended September 30, 2022 and 2021 were $43.6 million and $29.2 million, respectively, of qualifying costs associated with software and content development activities that are required to be capitalized under GAAP, such as those for our cloud solutions, as well as development costs associated with acquired companies. Qualifying capitalized development costs associated with our cloud solutions are subsequently amortized to cost of subscriptions revenue over the related assets' 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. Third Quarter 2022 Form 10-Q 35 Table of Contents Blackbaud, Inc. (Unaudited) General and administrative expense increased by $15.1 million or 43.6%, and $43.7 million, or 44.9%, during the three and nine months ended September 30, 2022, respectively, when compared to the same periods in 2021, primarily driven by the following: + Increases in Security Incident-related expenses, net of insurance, of $12.8 million and $27.9 million, respectively. See "Security Incident update" below on page 43 + Increases in compensation costs of $1.8 million and $8.4 million, respectively, primarily related to increased employee headcount due to our acquisition of EVERFI + Increases in acquisition and disposition-related costs of $2.4 million and $5.6 million, respectively, primarily related to aggregate noncash impairment charges of $1.3 million against certain operating lease right-of-use assets and property and equipment assets resulting from our decision to cease using a portion of EVERFI's leased office space. During the nine months ended September 30, 2022, we also recorded a $2.0 million noncash impairment of certain insignificant intangible assets that were held for sale + A $2.3 million noncash impairment charge during the nine months ended September 30, 2022 against previously capitalized software development costs that reduced the carrying value of those assets to zero. The impairment charge resulted primarily from our decision to end customer support for certain solutions + Increase in rent expense of $1.7 million during the nine months ended September 30, 2022 primarily related to leases assumed from our acquisition of EVERFI + Increase in third-party contractor costs of $1.4 million during the nine months ended September 30, 2022 + Increase in travel costs of $1.2 million during the nine months ended September 30, 2022 due to our easing of restrictions on non-essential employee travel, which went into effect during March 2020 in response to the COVID-19 pandemic - Increase in allocated corporate IT costs of $4.1 million during the nine months ended September 30, 2022 primarily related to investments in security tools. Depreciation, facilities and IT support costs are pooled and recorded to general and administrative expense and allocated to other lines of our condensed statements of comprehensive income based on headcount. 36 Third Quarter 2022 Form 10-Q Table of Contents Blackbaud, Inc. (Unaudited) Interest Expense Interest expense ($M) Percentages indicate expenses as a percentage of total revenue The increases in interest expense in dollars and as a percentage of total revenue during the three and nine months ended September 30, 2022, when compared to the same period in 2021, were primarily due to the new borrowings used to finance our acquisition of EVERFI. We currently expect interest expense for the full year 2022 to be approximately $34 million to $37 million although our interest expense in connection with the variable rate portion of our outstanding debt could increase in a rising interest rate environment. See Note 9 to our condensed consolidated financial statements in this report for more information regarding our derivative instruments, which we use to manage our variable interest rate risk, and Item 3. Quantitative and Qualitative Disclosures about Market Risk: Interest Rate Risk (below) for more information about our variable interest rate exposure and related risk. Deferred Revenue The table below compares the components of deferred revenue from our consolidated balance sheets: (dollars in millions) September 30, 2022 December 31, 2021 Change Deferred revenue (1) $ 396.6 $ 378.7 4.7 % Less: Long-term portion 2.9 4.2 (31.2) % Current portion (1) $ 393.7 $ 374.5 5.1 % (1) The individual amounts for each year may not sum to 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, billed annually in advance, and non-cancelable. We have been for several years successfully shifting our legacy customer base away from annual renewals and moving them onto multi-year renewal contracts. We generally invoice our customers with recurring revenue contracts in annual cycles 30 days prior to the end of each one-year period. The increase in deferred revenue during the nine months ended September 30, 2022 was primarily due to a seasonal increase in customer contract renewals . Historically, due to the timing of customer budget cycles, we have an increase in customer contract renewals at or near the beginning of our third quarter. Generally, our lowest balance of deferred revenue during the year is at the end of our first quarter. Third Quarter 2022 Form 10-Q 37 Table of Contents Blackbaud, Inc. (Unaudited) Income Taxes Income tax (benefit) provision ($M) Percentages indicate effective income tax rates For the six months ended June 30, 2022, we utilized the discrete effective tax rate method, as allowed by ASC 740-270-30-18, Income Taxes—Interim Reporting , to calculate its interim income tax provision. The discrete method is applied when the application of the estimated annual effective tax rate is impractical because it is not possible to reliably estimate the annual effective tax rate. The discrete method treats the year-to-date period as if it was the annual period and determines the income tax expense or benefit on that basis. We believe that, at this time, the use of this discrete method is no longer more appropriate than the annual effective tax rate method. The decreases in our effective income tax rate for the three and nine months ended September 30, 2022 when compared to the same periods in 2021 was primarily due to the effect of year-to-date losses relative to our forecasted permanent items, including foreign-derived intangible income deduction not generated in the prior year. Furthermore, the 2022 effective income tax rate was negatively impacted by expenses attributable to stock-based compensation. 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. 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. 38 Third Quarter 2022 Form 10-Q Table of Contents Blackbaud, Inc. (Unaudited) Three months ended September 30, Nine months ended September 30, (dollars in millions, except per share amounts) 2022 2021 Change 2022 2021 Change GAAP Revenue $ 261.3 $ 231.2 13.0 % $ 783.3 $ 679.8 15.2 % GAAP gross profit $ 140.4 $ 123.5 13.6 % $ 413.4 $ 360.7 14.6 % GAAP gross margin 53.7 % 53.4 % 52.8 % 53.1 % Non-GAAP adjustments: Add: Stock-based compensation expense 3.4 4.3 (19.9) % 11.3 14.9 (23.8) % Add: Amortization of intangibles from business combinations 11.9 8.6 38.6 % 36.8 26.6 38.4 % Add: Employee severance — — (335.7) % 0.3 — 1,100.0 % Subtotal (1) 15.3 12.9 18.8 % 48.5 41.5 16.8 % Non-GAAP gross profit (1) $ 155.7 $ 136.4 14.1 % $ 461.9 $ 402.2 14.8 % Non-GAAP gross margin 59.6 % 59.0 % 59.0 % 59.2 % GAAP (loss) income from operations $ (7.0) $ 11.8 (159.2) % $ (12.9) $ 31.5 (141.0) % GAAP operating margin (2.7) % 5.1 % (1.7) % 4.6 % Non-GAAP adjustments: Add: Stock-based compensation expense 27.9 28.9 (3.4) % 83.7 89.5 (6.5) % Add: Amortization of intangibles from business combinations 12.6 9.2 37.2 % 39.1 28.3 38.2 % Add: Employee severance 0.2 0.1 241.2 % 0.7 1.5 (54.0) % Add: Acquisition and disposition-related costs (2) 2.5 0.1 4,812.0 % 5.7 0.1 6,943.2 % Add: Restructuring and other real estate activities — (0.4) (100.0) % 0.1 (0.4) (117.2) % Add: Security Incident-related costs, net of insurance (3) 13.7 0.9 1,504.9 % 29.2 1.3 2,109.3 % Add: Impairment of capitalized software development costs — — — % 2.3 — 100.0 % Subtotal (1) 56.9 38.6 47.2 % 160.7 120.3 33.6 % Non-GAAP income from operations (1) $ 49.8 $ 50.5 (1.3) % $ 147.7 $ 151.8 (2.7) % Non-GAAP operating margin 19.1 % 21.8 % 18.9 % 22.3 % GAAP (loss) income before provision for income taxes $ (11.9) $ 8.7 (236.6) % $ (30.1) $ 17.7 (270.3) % GAAP net (loss) income $ (10.3) $ 6.2 (266.8) % $ (24.1) $ 12.8 (289.3) % Shares used in computing GAAP diluted (loss) earnings per share 51,692,152 48,274,072 7.1 % 51,519,340 48,259,956 6.8 % GAAP diluted (loss) earnings per share $ (0.20) $ 0.13 (253.8) % $ (0.47) $ 0.26 (280.8) % Non-GAAP adjustments: Add: GAAP income tax (benefit) provision (1.6) 2.5 (162.6) % (6.0) 4.9 (221.2) % Add: Total non-GAAP adjustments affecting income from operations 56.9 38.6 47.2 % 160.7 120.3 33.6 % Non-GAAP income before provision for income taxes 45.0 47.3 (5.0) % 130.5 138.0 (5.4) % Assumed non-GAAP income tax provision (4) 9.0 9.5 (5.0) % 26.1 27.6 (5.4) % Non-GAAP net income (1) $ 36.0 $ 37.9 (5.0) % $ 104.4 $ 110.4 (5.4) % Shares used in computing non-GAAP diluted earnings per share 52,362,781 48,274,072 8.5 % 51,985,207 48,259,956 7.7 % Non-GAAP diluted earnings per share $ 0.69 $ 0.78 (11.5) % $ 2.01 $ 2.29 (12.2) % (1) The individual amounts for each year may not sum to non-GAAP gross profit, subtotal, non-GAAP income from operations or non-GAAP net income due to rounding. (2) Includes a $2.0 million noncash impairment of intangible assets held for sale during the three and nine months ended September 30, 2022. (3) Includes Security Incident-related costs incurred during the three and nine months ended September 30, 2022 of $13.7 million and $31.1 million, respectively, net of insurance recoveries during the same periods of $— million and $1.9 million, respectively, and during the three and nine months ended September 30, 2021 of $11.4 million and $35.9 million, respectively, net of insurance recoveries during the same periods of $10.6 million and $34.6 million, respectively. Recorded expenses consisted primarily of payments to third-party service providers and consultants, including legal fees, as well as settlements of customer claims and accruals for certain loss contingencies. Not included in this adjustment were costs associated with enhancements to our cybersecurity program. For full year 2022, we currently expect net pre-tax expense of approximately $30 million to $35 million for ongoing legal fees related to the Security Incident. In line with our policy, legal fees are expensed as incurred. For full year 2022, we currently expect net cash outlays of approximately $15 million to $25 million for ongoing legal fees related to the Security Incident. There are some Security Incident-related matters for which we have not recorded a liability for a loss contingency as of September 30, 2022 because we are unable at this time to reasonably estimate the possible loss or range of loss. (4) We apply a non-GAAP effective tax rate of 20.0% when calculating non-GAAP net income and non-GAAP diluted earnings per share. Third Quarter 2022 Form 10-Q 39 Table of Contents Blackbaud, Inc. (Unaudited) 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. 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 our current business’ organic revenue growth and revenue run-rate. (dollars in millions) Three months ended September 30, Nine months ended September 30, 2022 2021 2022 2021 GAAP revenue $ 261.3 $ 231.2 $ 783.3 $ 679.8 GAAP revenue growth 13.0 % 15.2 % Add: Non-GAAP acquisition-related revenue (1) — 26.0 — 77.1 Less: Non-GAAP revenue from divested businesses (2) — (0.4) — (0.4) Total Non-GAAP adjustments — 25.6 — 76.7 Non-GAAP organic revenue (3) $ 261.3 $ 256.9 $ 783.3 $ 756.6 Non-GAAP organic revenue growth 1.7 % 3.5 % Non-GAAP organic revenue (3) $ 261.3 $ 256.9 $ 783.3 $ 756.6 Foreign currency impact on Non-GAAP organic revenue (4) 4.9 — 8.7 — Non-GAAP organic revenue on constant currency basis (4) $ 266.2 $ 256.9 $ 792.1 $ 756.6 Non-GAAP organic revenue growth on constant currency basis 3.6 % 4.7 % GAAP recurring revenue $ 249.4 $ 218.5 $ 746.6 $ 642.3 GAAP recurring revenue growth 14.1 % 16.2 % Add: Non-GAAP acquisition-related revenue (1) — 22.8 — 68.8 Less: Non-GAAP recurring revenue from divested businesses (2) — (0.3) — (0.3) Total Non-GAAP adjustments — 22.5 — 68.4 Non-GAAP organic recurring revenue (3) $ 249.4 $ 241.0 $ 746.6 $ 710.7 Non-GAAP organic recurring revenue growth 3.5 % 5.0 % Non-GAAP organic recurring revenue (3) $ 249.4 $ 241.0 $ 746.6 $ 710.7 Foreign currency impact on non-GAAP organic recurring revenue (4) 4.4 — 7.8 — Non-GAAP organic recurring revenue on constant currency basis (4) $ 253.8 $ 241.0 $ 754.4 $ 710.7 Non-GAAP organic recurring revenue growth on constant currency basis 5.3 % 6.1 % (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. (2) Non-GAAP revenue from divested businesses excludes revenue associated with divested businesses. The exclusion of the prior period revenue is to present the results of the divested business with the results of the combined company for the same period of time in both the prior and current periods. (3) Non-GAAP organic revenue and non-GAAP organic recurring revenue for the prior year periods presented herein may not agree to non-GAAP organic revenue and non-GAAP organic recurring revenue presented in the respective prior period quarterly financial information solely due to the manner in which non-GAAP organic revenue growth and non-GAAP organic recurring revenue growth are calculated. (4) To determine non-GAAP organic revenue growth and non-GAAP organic recurring 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. 40 Third Quarter 2022 Form 10-Q Table of Contents Blackbaud, Inc. (Unaudited) Rule of 40 We previously defined Rule of 40 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 and content development costs; stock-based compensation; employee severance; acquisition and disposition-related costs; restructuring and other real estate activities; Security Incident-related costs, net of insurance; and impairment of capitalized software development costs. Beginning in the fiscal quarter ended June 30, 2022, we now also include in non-GAAP adjusted EBITDA impairment of capitalized software development costs because we believe it is not directly related to our operating performance in any particular period. Three months ended September 30, Nine months ended September 30, (dollars in millions) 2022 2021 Change 2022 2021 Change GAAP net (loss) income $ (10.3) $ 6.2 (266.8) % $ (24.1) $ 12.8 (289.3) % Non-GAAP adjustments: Add: Interest, net 8.7 3.9 121.0 % 25.0 13.9 80.4 % Add: GAAP income tax (benefit) provision (1.6) 2.5 (162.6) % (6.0) 4.9 (221.2) % Add: Depreciation 3.5 3.1 12.2 % 10.6 9.5 12.2 % Add: Amortization of intangibles from business combinations 12.6 9.2 37.2 % 39.1 28.3 38.2 % Add: Amortization of software and content development costs (1) 9.8 8.0 22.7 % 28.5 24.1 18.5 % Subtotal (2) 33.0 26.7 23.4 % 97.3 80.6 20.6 % Non-GAAP EBITDA (2) $ 22.6 $ 32.9 (31.2) % $ 73.1 $ 93.4 (21.7) % Non-GAAP EBITDA margin 8.7 % 9.3 % Non-GAAP adjustments: Add: Stock-based compensation expense 27.9 28.9 (3.4) % 83.7 89.5 (6.5) % Add: Employee severance 0.2 0.1 241.2 % 0.7 1.5 (54.0) % Add: Acquisition and disposition-related costs (3) 2.5 0.1 4,812.0 % 5.7 0.1 6,943.2 % Add: Restructuring and other real estate activities — (0.4) (100.0) % 0.1 (0.4) (117.2) % Add: Security Incident-related costs, net of insurance (3) 13.7 0.9 1,504.9 % 29.2 1.3 2,109.3 % Add: Impairment of capitalized software development costs — — — % 2.3 — 100.0 % Subtotal (2) 44.3 29.5 50.3 % 121.6 92.0 32.2 % Non-GAAP Adjusted EBITDA (2) $ 66.9 $ 62.4 7.3 % $ 194.7 $ 185.4 5.0 % Non-GAAP Adjusted EBITDA margin 25.6 % 24.9 % Rule of 40 (4) 27.3 % 28.4 % Non-GAAP adjusted EBITDA 66.9 62.4 7.3 % 194.7 185.4 5.0 % Foreign currency impact on Non-GAAP adjusted EBITDA (5) 2.8 (1.1) (357.5) % 5.0 (3.3) (249.6) % Non-GAAP adjusted EBITDA on constant currency basis (5) $ 69.8 $ 61.3 13.8 % $ 199.7 $ 182.0 9.7 % Non-GAAP adjusted EBITDA margin on constant currency basis 26.2 % 25.2 % Rule of 40 on constant currency basis (6) 29.8 % 29.9 % (1) Includes amortization expense related to software development costs and amortization expense from capitalized cloud computing implementation costs. (2) The individual amounts for each year may not sum to subtotal, non-GAAP EBITDA, non-GAAP adjusted EBITDA or non-GAAP adjusted EBITDA on a constant currency basis due to rounding. (3) See additional details in the reconciliation of GAAP to Non-GAAP operating income above. (4) Measured by non-GAAP organic revenue growth plus non-GAAP adjusted EBITDA margin. See Non-GAAP organic revenue growth table above. (5) To determine non-GAAP adjusted EBITDA on a constant currency basis, non-GAAP adjusted EBITDA 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. (6) Measured by non-GAAP organic revenue growth on constant currency basis plus non-GAAP adjusted EBITDA margin on constant currency basis. See Non-GAAP organic revenue growth table above. Third Quarter 2022 Form 10-Q 41 Table of Contents Blackbaud, Inc. (Unaudited) Non-GAAP free cash flow and non-GAAP adjusted 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. Non-GAAP adjusted 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, plus cash outflows, net of insurance, related to the Security Incident. We believe non-GAAP free cash flow and non-GAAP adjusted free cash flow provides useful measures of the Company's operating performance. Non-GAAP adjusted free cash flow is not intended to represent and should not be viewed as the amount of residual cash flow available for discretionary expenditures. Nine months ended September 30, (dollars in millions) 2022 2021 Change GAAP net cash provided by operating activities $ 189.8 $ 169.8 11.8 % Less: purchase of property and equipment (10.5) (8.3) 26.2 % Less: capitalized software and content development costs (42.8) (29.7) 44.2 % Non-GAAP free cash flow (1) $ 136.5 $ 131.8 3.6 % Add: Security Incident-related cash flows, net of insurance 9.5 4.5 109.6 % Non-GAAP adjusted free cash flow (1) $ 146.1 $ 136.3 7.1 % (1) The individual amounts for each year may not sum to non-GAAP free cash flow or non-GAAP adjusted free cash flow due to rounding. Seasonality Our revenues normally fluctuate as a result of certain seasonal variations in our business. 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. 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. Our transactional revenue has historically been at its lowest in the first quarter due to the timing of customer fundraising initiatives and events. 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. 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, other than transaction-based costs related to our payments services, 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 acquired companies, delivery of professional services and occurrence of customer events, as well as merit-based salary increases, among other factors. Historically, due to lower revenues in our first quarter, combined with 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 generally 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 base salary merit increases, which occur in July. In addition, deferred revenues can vary on a seasonal basis due to the timing of customer contract renewals and student enrollments or significant acquisitions. 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, large dollar customer bookings and contract renewals, or as a result of acquisitions, new market opportunities, new solution introductions, the COVID-19 pandemic or other factors. 42 Third Quarter 2022 Form 10-Q Table of Contents Blackbaud, Inc. (Unaudited) Liquidity and Capital Resources The following table presents selected financial information about our financial position: (dollars in millions) September 30, 2022 December 31, 2021 Change Cash and cash equivalents $ 31.4 $ 55.1 (43.0) % Property and equipment, net 109.5 111.4 (1.8) % Software and content development costs, net 135.6 121.4 11.7 % Total carrying value of debt 854.1 956.2 (10.7) % Working capital (323.5) (258.7) (25.1) % The following table presents selected financial information about our cash flows: Nine months ended September 30, (dollars in millions) 2022 2021 Change Net cash provided by operating activities $ 189.8 $ 169.8 11.8 % Net cash used in investing activities (67.8) (38.0) 78.4 % Net cash used in financing activities (384.2) (533.1) (27.9) % Our principal sources of liquidity are our 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, market acceptance of our solutions and services, the volume and size of transactions for which we process payments and our customers' ability to pay. 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. We also believe that we will be able to continue to meet our long-term cash requirements due to our anticipated cash flow from operations, solid financial position and ability to access capital from financial markets. To the extent we undertake future material acquisitions or, investments or unanticipated capital or operating expenditures, including in connection with the Security Incident, we may require additional capital. In that context, we regularly evaluate opportunities to enhance our capital structure, including through potential debt or equity issuances. As a well-known seasoned issuer, we filed an automatic shelf registration statement for an undetermined amount of debt and equity securities with the SEC on January 14, 2022. Under this universal shelf registration statement we may offer and sell, from time to time, debt securities, common stock, preferred stock, depositary shares, warrants, stock purchase contracts and stock purchase units. Subject to certain conditions, this registration statement will be effective through January 13, 2024. At September 30, 2022, our total cash and cash equivalents balance included approximately $15.9 million of cash that was held by operations 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 the funds. We currently do not intend nor anticipate a need to repatriate our cash held outside the U.S. Operating Cash Flow Our cash flows from operations are derived principally from: (i) our earnings from on-going operations prior to non-cash expenses such as depreciation, amortization, stock-based compensation, deferred 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. Third Quarter 2022 Form 10-Q 43 Table of Contents Blackbaud, Inc. (Unaudited) Working capital changes are composed of changes in accounts receivable, prepaid expenses and other assets, trade accounts payable, accrued expenses and other liabilities, and deferred revenue. Net cash provided by operating activities increased by $20.0 million during the nine months ended September 30, 2022, when compared to the same period in 2021, primarily due to a $45.5 million decrease in net income adjusted for non-cash expenses and a $65.5 million increase in cash flow from operations associated with working capital. The increase in cash flow from operations associated with working capital during the nine months ended September 30, 2022 , when compared to the same period in 2021, was primarily due to: • a seasonal increase in the collection of customer contract renewal billings and an increase in the collection of customer account balances from an aging improvement initiative; • a decrease in probable insurance recoveries related to the Security Incident as we have received payment for all of the related insurance claims; • an increase in taxes payable; and • fluctuations in the timing of vendor payments. Workforce reduction We have taken steps to better align our workforce with our strategic priorities to drive efficiencies and minimize any potential impacts from the current uncertain macroeconomic environment. This recently included further elimination of open positions as well as the decision to reduce our workforce. As a result of the workforce targeted reduction, we expect to incur between $6 million and $8 million in pre-tax employee severance costs primarily during the fourth quarter of 2022. We expect this workforce reduction and other cost actions will reduce our planned future pre-tax cost run rate by approximately $40 million to $50 million beginning in 2023, partially offset by continued investments in cybersecurity and innovation. Security Incident update As discussed in Note 10 to our unaudited, condensed consolidated financial statements included in this report, t otal costs related to the Security Incident that we expect will be recoverable has exceeded the limit of our insurance coverage . Accordingly, we expect that the Security Incident will continue to negatively impact our GAAP profitability and GAAP cash flow for the foreseeable future (see discussion regarding our non-GAAP financial measures beginning on page 38 ). For full year 2022, we currently expect net pre-tax expense of approximately $30 million to $35 million for ongoing legal fees related to the Security Incident. In line with our policy, legal fees are expensed as incurred. For full year 2022, we currently expect net cash outlays of approximately $15 million to $25 million for ongoing legal fees related to the Security Incident. As of September 30, 2022, we have recorded approximately $5.0 million in aggregate liabilities for a loss contingencies related to the Security Incident that we believe we can reasonably estimate. Certain of these recorded charges reflect the low end of a range of estimated losses based on our determination that no estimate within that range was better than any other amount. It is reasonably possible that actual losses in the future for those matters will be in excess of the amounts accrued, but we are unable at this time to reasonably estimate the possible additional loss. There are other Security Incident-related matters, including customer claims, customer constituent class actions and governmental investigations, for which we have not recorded a liability for a loss contingency as of September 30, 2022 because we are unable at this time to reasonably estimate the possible loss or range of loss. Investing Cash Flow Net cash used in investing activities of $67.8 million increased by $29.8 million during the nine months ended September 30, 2022, when compared to the same period in 2021. During the nine months ended September 30, 2022, we used $20.9 million of net cash for our acquisitions of EVERFI and Kilter, comprised primarily of (i) $17.4 million that had not been paid by EVERFI to its former option holders as of December 31, 2021, solely due to the timing of the acquisition on the last day of 2021; (ii) $2.9 million that was paid to acquire Kilter; and (iii) $2.6 million that was paid to a number of EVERFI's selling shareholders after determining they would be paid in cash, rather than shares of our common stock. 44 Third Quarter 2022 Form 10-Q Table of Contents Blackbaud, Inc. (Unaudited) We used $42.8 million for software development costs, which was up $13.1 million from cash spent during the same period in 2021, primarily due to the inclusion of EVERFI's software and content development activities. We also spent $10.5 million of cash for purchases of property and equipment during the nine months ended September 30, 2022, which was an increase of $2.2 million when compared to the same period in 2021. Financing Cash Flow During the nine months ended September 30, 2022, we had a net decrease in borrowings of $102.5 million. We paid $36.1 million to satisfy tax obligations of employees upon settlement of equity awards during the nine months ended September 30, 2022 compared to $39.0 million during the same period in 2021. The amount of taxes paid by us on behalf of employees related to the settlement of equity awards varies from period to period based upon the timing of grants and vesting, 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. During the nine months ended September 30, 2022, cash flow from financing activities associated with changes in restricted cash due to customers decreased $243.1 million, compared to a decrease of $387.0 million during the same period in 2021. This line in the statement of cash flows represents the change in the amount of restricted cash held and payable by us to customers from one period to the next. Stock repurchase program In December 2021, our Board of Directors reauthorized and replenished our 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 three and nine months ended September 30, 2022, we did not purchase any shares. The remaining amount available to purchase stock under the stock repurchase program was $250.0 million as of September 30, 2022. 2020 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 September 30, 2022, our available borrowing capacity under the 2020 Credit Facility was $326.9 million. The 2020 Credit Facility matures in October 2025. At September 30, 2022, the carrying amount of our debt under the 2020 Credit Facility was $795.5 million. Our average daily borrowings during the three and nine months ended September 30, 2022 were $834.7 million and $886.8 million, respectively. The following is a summary of the financial covenants under the 2020 Credit Facility: Financial covenant Requirement Ratio as of September 30, 2022 Net leverage ratio (1) ≤ 4.25 to 1.00 3.10 to 1.00 Interest coverage ratio ≥ 2.50 to 1.00 9.42 to 1.00 (1) Under the terms of the 2020 Credit Facility, the Net Leverage Ratio requirement may be increased by up to 0.50 provided we satisfy certain requirements, including a permitted business acquisition, and provided that the maximum Net Leverage Ratio shall not exceed 4.25 to 1.00. 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 September 30, 2022, we were in compliance with our debt covenants under the 2020 Credit Facility. See Note 8 to our unaudited, condensed consolidated financial statements included in this report for additional information regarding the 2020 Credit Facility. Third Quarter 2022 Form 10-Q 45 Table of Contents Blackbaud, Inc. (Unaudited) Commitments and Contingencies Payments due by period (in millions) Less than 1 year More than 1 year Total (1) Recorded contractual obligations: Debt $ 18.2 $ 839.3 $ 857.5 Operating leases 10.4 55.4 65.9 Contingent consideration — 2.7 2.7 Unrecorded contractual obligations: Purchase obligations 55.1 180.9 236.0 Interest payments on debt 33.2 102.6 135.9 Total contractual obligations (1) $ 116.9 $ 1,181.0 $ 1,297.9 (1) The individual amounts may not sum to the total due to rounding. Debt As of September 30, 2022, we had total remaining principal payments of $857.5 million. These payments represent 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 September 30, 2022 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. See Note 8 to our unaudited, condensed consolidated financial statements in this report for more information. Interest payments on debt In addition to principal payments, as of September 30, 2022, we expect to pay interest expense over the life of our debt obligations of approximately $135.9 million. These payments represent our estimated future interest payments on debt using our debt balances and the related weighted average effective interest rates as of September 30, 2022, which includes the effect of interest rate swap agreements. 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 on our remaining principal payments described above. Operating leases As of September 30, 2022, we had remaining operating lease payments of $65.9 million. These payments have not been reduced by sublease income, incentive payments, reimbursement of leasehold improvements or the amount representing imputed interest of $11.3 million. Our operating leases are generally for corporate offices, subleased offices and certain equipment and furnit ure. Given our remote-first workforce strategy and real estate footprint optimization efforts, as discussed above, we do not anticipate entering any new, material operating leases for offices for the foreseeable future. See Note 10 to our unaud ited, condensed consolidated financial statements in this report for more information. Purchase obligations As of September 30, 2022, we had remaining purchase obligations of $236.0 million. These purchase obligations are 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. Our purchase obligations are not recorded as liabilities on our consolidated balance sheets as of September 30, 2022, as we had not received the related services. See Note 10 to our unaudited, condensed consolidated financial statements in this report for more information. The total liability for uncertain tax positions as of September 30, 2022 and December 31, 2021, was $4.1 million and $3.7 million , respectively. Our accrued interest and penalties related to tax positions taken on our tax returns was insignificant as of September 30, 2022 and December 31, 2021. 46 Third Quarter 2022 Form 10-Q Table of Contents Blackbaud, Inc. (Unaudited) Contingent consideration In connection with our acquisition of Kilter, we are obligated to pay contingent consideration upon the achievement of certain milestones. For information regarding our contingent consideration obligations, see Note 3 to our unaudited, condensed consolidated financial statements in this report. Foreign Currency Exchange Rates Approximately 16% of our total revenue for the nine months ended September 30, 2022 was generated from 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 accumulated other comprehensive income (loss) as a component of stockholders’ equity, was a loss of $22.8 million as of September 30, 2022 and income of $1.3 million as of December 31, 2021. We have entered into foreign currency forward contracts to hedge a portion of the foreign currency exposure that arises on translation of our investments denominated in British Pounds into U.S. dollars. 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 revenue and expenses denominated in non-U.S. currencies. During the nine months ended September 30, 2022, 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, primarily those between the U.S. dollar and both the British Pound and Canadian dollar, the impact has generally not been material to our consolidated results of operations or financial position. However, we currently expect that fluctuations in foreign currency exchange rates will have a significant negative impact on our total revenue for the full year 2022. For the nine months ended September 30, 2022, the fluctuation in foreign currency exchange rates reduced our total revenue and our income from operations by $8.7 million and $2.2 million, respectively. We have entered into foreign currency forward contracts to hedge revenues denominated in the Canadian dollar against changes in the exchange rate with the U.S. dollar. 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. Critical Accounting Policies and Estimates There have been no significant changes in our critical accounting policies and estimates during the nine months ended September 30, 2022 as compared to those disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. 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 unaudited, condensed consolidated financial statements in this report. Third Quarter 2022 Form 10-Q 47 Table of Contents Blackbaud, Inc. (Unaudited)