UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-Q

 

 

 

Commission file number 000-50784

 

Blackboard Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Registrant’s telephone number, including area code:

(202) 463-4860

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

 

 

Blackboard Inc.

Quarterly Report on Form 10-Q
For the Quarter Ended September 30, 2010

INDEX

 

 

Throughout this Quarterly Report on Form 10-Q, the terms “we,” “us,” “our” and “Blackboard” refer to Blackboard Inc. and its subsidiaries.

PART I — FINANCIAL INFORMATION

 

Item 1.  Consolidated Financial Statements

 

BLACKBOARD INC.

 

UNAUDITED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

 

See notes to unaudited consolidated financial statements.

BLACKBOARD INC.

 

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share and per share data)

 

 

See notes to unaudited consolidated financial statements.

BLACKBOARD INC.

 

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

 

See notes to unaudited consolidated financial statements.

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

For the Three and Nine Months Ended September 30, 2009 and 2010

 

In these Notes to Unaudited Consolidated Financial Statements, the terms “the Company” and “Blackboard” refer to Blackboard Inc. and its subsidiaries.

 

 

Blackboard Inc. (the “Company”) is a leading provider of enterprise software applications and related services to the education industry. The Company’s clients include colleges, universities, schools and other education providers, textbook publishers and student-focused merchants who serve these education providers and their students, and corporate and government clients.

 

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The results of operations for the three and nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for the full fiscal year. The consolidated balance sheet at December 31, 2009 has been derived from the audited consolidated financial statements at that date but does not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements.

 

These consolidated financial statements should be read in conjunction with the audited consolidated financial statements as of December 31, 2008 and 2009 and for each of the three years in the period ended December 31, 2009 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 17, 2010.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries after elimination of all significant intercompany balances and transactions.

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Fair Value Measurements

 

Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability. The Company evaluates the fair value of certain assets and liabilities using the following fair value hierarchy which ranks the quality and reliability of inputs, or assumptions, used in the determination of fair value:

 

Level 1 — quoted prices in active markets for identical assets and liabilities

 

Level 2 — inputs other than Level 1 quoted prices that are directly or indirectly observable

 

Level 3 — unobservable inputs that are not corroborated by market data

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

The Company evaluates assets and liabilities subject to fair value measurements on a recurring and nonrecurring basis to determine the appropriate level to classify them for each reporting period. This determination requires significant judgments to be made by the Company. The following tables set forth the Company’s assets and liabilities that were measured at fair value as of December 31, 2009 and September 30, 2010, by level within the fair value hierarchy (in thousands):

 

 

 

 

 

Assets and liabilities that are measured at fair value on a non-recurring basis include intangible assets and goodwill. These items are recognized at fair value when they are considered to be impaired. During the three and nine months ended September 30, 2010, there were no fair value adjustments for assets and liabilities measured on a non-recurring basis.

 

The Company has determined that although some market data was available, the investment in the common stock warrant was principally valued using the Company’s own assumptions in calculating the estimate of fair value including a discounted cash flow and comparable company analysis and, as a result, is classified as a Level 3 instrument. There were no changes in the fair value of the investment in common stock warrant during the three and nine months ended September 30, 2010.

 

The Company discloses fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. Due to their short-term nature, the carrying amounts reported in the consolidated financial statements approximate the fair value for accounts receivable, accounts payable and accrued expenses.

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Investment in Common Stock Warrant

 

The Company holds a warrant to purchase common stock in an entity that provides technology support services to educational institutions, including the Company’s customers, that is exercisable for 9.9% of the common shares of the entity. This common stock warrant meets the definition of a derivative. In determining the fair value of the common stock warrant, the Company considered discounted cash flow and comparable company analyses, and at times may consider market data such as equity financings similar to the one the investee received in 2009. The fair value of the common stock warrant of $3.1 million is recorded as investment in common stock warrant on the Company’s unaudited consolidated balance sheets as of December 31, 2009 and September 30, 2010. The Company will continue to evaluate the fair value of this instrument in subsequent reporting periods and any changes in value will be recognized in the consolidated statements of operations.

 

Revenue Recognition and Deferred Revenue

 

The Company derives revenues from two sources: product sales and professional services sales. Product revenues include software license fees, subscription fees from customers accessing the Company’s on-demand application services, hardware, premium support and maintenance, and hosting revenues. Professional services revenues include training and consulting services. The Company’s software does not require significant modification and customization services. Where services are not essential to the functionality of the software, the Company begins to recognize software licensing revenues when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the fee is fixed and determinable; and (4) collectibility is probable.

 

The Company does not have vendor-specific objective evidence (“VSOE”) of fair value for support and maintenance separate from software for the majority of its products. Accordingly, when licenses are sold in conjunction with the Company’s support and maintenance, the Company recognizes license revenue over the term of the maintenance service period. When licenses of certain offerings are sold in conjunction with support and maintenance where the Company does have VSOE, the Company recognizes the license revenue upon delivery of the license and recognizes the support and maintenance revenue over the term of the maintenance service period.

 

Hosting fees and set-up fees are recognized ratably over the term of the hosting agreement. After any necessary installation services are performed, hardware revenues are recognized when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the fee is fixed and determinable; and (4) collectibility is probable.

 

The Company early adopted new accounting guidance on January 1, 2010 that impacts the Company’s accounting for (a) non-software components of tangible products and (b) software components of tangible products that are sold, licensed, or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s essential functionality. The Company has applied this guidance on a prospective basis for arrangements executed or significantly modified after December 31, 2009. The Company allocates the overall consideration from such sales to each deliverable using a best estimate of the selling price of individual deliverables in the arrangement in the absence of VSOE or other third-party evidence of the selling price. Prior to the adoption of this new accounting guidance, in the absence of VSOE, all revenue from such sales was recognized ratably over the term of the applicable maintenance service period.

 

As a result of the adoption of this new accounting guidance, the product revenues and cost of product revenues related to hardware and software sales in the Blackboard Transact product line will generally be recognized upfront upon delivery of the product to the customer. Product revenues in the Blackboard Transact product line generally consist of hardware, software and support. Generally, the consideration allocated to the hardware and software deliverables is determined using a best estimate of selling price which the Company estimates based on an analysis of market data and the Company’s internal cost to deliver each element. Generally, the consideration allocated to the

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

support deliverable is based on third party evidence. During the three and nine months ended September 30, 2010, the Company recognized product revenues of approximately $17.8 million and $27.5 million, respectively, under this new accounting guidance, which related to ratable and non-ratable revenue streams and is comprised of arrangements executed or significantly modified after December 31, 2009. In addition, approximately $3.3 million is recorded as deferred revenues on the unaudited consolidated balance sheet as of September 30, 2010 related to these arrangements executed or significantly modified after December 31, 2009. The effect of changes in either selling price or the method or assumptions used to determine selling price for a specific deliverable could have a material effect on the allocation of the overall consideration of an arrangement.

 

As a result of the adoption of this new accounting guidance, revenues, income from operations, net income and basic and diluted earnings per share are approximately $10.4 million, $8.0 million, $5.5 million, $0.16 and $0.16, respectively, higher during the three months ended September 30, 2010 than if the Company had accounted for these sales under the accounting guidance in effect prior to January 1, 2010. Further, revenues, income from operations, net income and basic and diluted earnings per share are approximately $15.9 million, $12.3 million, $8.5 million, $0.25 and $0.24, respectively, higher during the nine months ended September 30, 2010 than if the Company had accounted for these sales under the accounting guidance in effect prior to January 1, 2010. The Company expects the adoption of this new accounting guidance to continue to have a material effect on the Company’s consolidated results of operations and financial condition.

 

The Company’s sales arrangements may include professional services sold separately under professional services agreements that include training and consulting services. Revenues from these arrangements are accounted for separately from the license revenue because they meet the criteria for separate accounting. The more significant factors considered in determining whether revenues should be accounted for separately include the nature of the professional services, such as consideration of whether the professional services are essential to the functionality of the licensed product, degree of risk, availability of professional services from other vendors and timing of payments. Professional services that are sold separately from license revenue are recognized as the professional services are performed on a time-and-materials basis.

 

The Company does not offer specified upgrades or incrementally significant discounts. Advance payments are recorded as deferred revenues until the product is shipped, services are delivered or obligations are met and the revenues can be recognized. Deferred revenues represent the excess of amounts invoiced over amounts recognized as revenues. The Company provides non-specified upgrades of its products only on a when-and-if-available basis. The Company accounts for any contingencies, such as rights of return, conditions of acceptance, warranties and price protection, as a separate element. Historically, the effect of accounting for these contingencies included in revenue arrangements has not been material.

 

Cost of Revenues and Deferred Cost of Revenues

 

Cost of revenues includes all direct materials, direct labor, direct shipping and handling costs, telecommunications costs related to the Blackboard Connect product, and those indirect costs related to revenue such as indirect labor, materials and supplies, equipment rent, and amortization of software developed internally and software license rights. Cost of product revenues excludes amortization of acquired technology intangibles resulting from acquisitions, which is separately included on the unaudited consolidated statements of operations as amortization of intangibles acquired in acquisitions. Amortization expense related to acquired technology was $2.5 million and $2.3 million for the three months ended September 30, 2009 and 2010, respectively, and $8.2 million and $7.7 million for the nine months ended September 30, 2009 and 2010, respectively.

 

Deferred cost of revenues represents the cost of hardware (if sold as part of a complete system) and software that has been purchased and has been sold in conjunction with the Company’s products. As a result of new accounting guidance adopted on January 1, 2010, the Company generally recognizes these costs upon shipment of the products to its clients. In general, prior to the adoption of the new accounting guidance on January 1, 2010, the Company initially deferred these costs and recognized them into expense over the period in which the related

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

revenue was recognized. The Company does not have transactions in which the deferred cost of revenues exceeds deferred revenues.

 

Basic and Diluted Net Income per Common Share

 

Basic net income per common share excludes dilution for potential common stock issuances and is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted net income per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.

 

The following table provides a reconciliation of the numerators and denominators used in computing basic and diluted net income per common share:

 

 

The dilutive effect of options to purchase an aggregate of 2,577,649 and 2,472,619 shares were not included in the computations of diluted net income per common share for the three months ended September 30, 2009 and 2010, respectively, as their effect would be anti-dilutive. The dilutive effect of options to purchase an aggregate of 3,383,508 and 2,116,429 shares were not included in the computations of diluted net income per common share for the nine months ended September 30, 2009 and 2010, respectively, as their effect would be anti-dilutive.

 

Comprehensive Net Income (Loss)

 

Comprehensive net income (loss) includes net income (loss), combined with unrealized gains and losses not included in earnings and reflected as a separate component of stockholders’ equity. For the Company, such items consist primarily of foreign currency translation losses, which were $0.2 million for the three and nine months ended September 30, 2009 and 2010, representing the difference between net income and comprehensive net loss for the respective periods.

 

 

Saf-T-Net, Inc. Merger

 

On March 19, 2010, the Company completed its merger with Saf-T-Net, Inc. (“Saf-T-Net”) pursuant to the Agreement and Plan of Merger dated March 7, 2010. Pursuant to the Agreement and Plan of Merger, the Company paid merger consideration of $34.4 million. The effective cash portion of the purchase price of Saf-T-Net before

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

transaction costs of approximately $0.5 million was $34.2 million, net of Saf-T-Net’s March 19, 2010 cash balance of $0.2 million. The transaction costs are reflected in general and administrative expenses in the consolidated statements of operations. The Company has included the financial results of Saf-T-Net in its consolidated financial statements beginning March 20, 2010.

 

Saf-T-Net is the provider of AlertNow, a leading messaging and mass notification solution for the K-12 marketplace. The Company believes the merger with Saf-T-Net supports the Company’s long-term strategic direction and the demands for innovative technology in the education industry. The Company believes that the merger with Saf-T-Net will help the Company meet the growing demands of its clients, including the ability to send mass communications via various means.

 

The Company has accounted for the merger under the acquisition method of accounting. Assets acquired and liabilities assumed were recorded at their fair values as of March 19, 2010. The total preliminary purchase price was $34.4 million, excluding the estimated acquisition related transaction costs of approximately $0.5 million and excluding acquired cash. Acquisition-related transaction costs include investment banking, legal and accounting fees, and other external costs directly related to the merger.

 

Preliminary Purchase Price Allocation

 

Under the acquisition method of accounting, the total estimated purchase price was allocated to Saf-T-Net’s net tangible liabilities and intangible assets based on their estimated fair values as of March 19, 2010. The Company recorded the excess of the purchase price over the net tangible liabilities and identifiable intangible assets as goodwill. The preliminary allocation of the purchase price shown in the table below was based upon management’s preliminary valuation, which was based on estimates and assumptions that are subject to change. The areas of the purchase price allocation that are not yet finalized relate primarily to income and non-income based taxes. The preliminary estimated purchase price is allocated as follows (in thousands):

 

 

Prior to the end of the measurement period for finalizing the purchase price allocation, if information becomes available that would indicate adjustments to the purchase price allocation are required, any such adjustments will be included in the purchase price allocation retrospectively.

 

Of the total estimated purchase price, a preliminary estimate of $7.3 million has been allocated to net tangible liabilities acquired, and $15.7 million has been allocated to definite-lived intangible assets acquired. Definite-lived intangible assets consist of the value assigned to Saf-T-Net’s customer relationships of $12.7 million, developed and core technology of $2.3 million, and trademarks of $0.7 million.

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The value assigned to Saf-T-Net’s customer relationships was determined by discounting the estimated cash flows associated with the existing customers as of the date the merger was consummated taking into consideration estimated attrition of the existing customer base. The estimated cash flows were based on revenues for those existing customers net of operating expenses and net of capital charges for other tangible and intangible assets that contribute to the projected cash flow from those customers. The projected revenues were based on assumed revenue growth rates and customer renewal rates. Operating expenses were estimated based on the supporting infrastructure expected to sustain the assumed revenue growth rates. Net capital charges for assets that contribute to projected customer cash flow were based on the estimated fair value of those assets. A discount rate of 19% was deemed appropriate for valuing the existing customer base and was based on the risks associated with the respective cash flows taking into consideration the Company’s weighted average cost of capital. The Company amortizes the value of Saf-T-Net’s customer relationships on a straight-line basis over seven years from the acquisition date. Amortization of customer relationships is not deductible for tax purposes.

 

The value assigned to Saf-T-Net’s developed and core technology was determined by discounting the estimated royalty savings associated with an estimated royalty rate for the use of the technology to their present value. Developed and core technology, which consists of products that have reached technological feasibility, includes products in Saf-T-Net’s current product line. The royalty rates used to value the technology were based on estimates of prevailing royalty rates paid for the use of similar technology and technology in market transactions involving licensing arrangements of companies that operate in service-related industries. A discount rate of 19% was deemed appropriate for valuing developed and core technology and was based on the risks associated with the respective royalty savings taking into consideration the Company’s weighted average cost of capital. The Company amortizes the developed and core technology on a straight-line basis over three years from the acquisition date. Amortization of developed and core technology is not deductible for tax purposes.

 

The value assigned to Saf-T-Net’s trademarks was determined by discounting the estimated royalty savings associated with an estimated royalty rate for the use of the trademarks to their present value. The trademarks consist of Saf-T-Net’s trade name and various trademarks related to its existing product lines. The royalty rates used to value the trademarks were based on estimates of prevailing royalty rates paid for the use of similar trade names and trademarks in market transactions involving licensing arrangements of companies that operate in service-related industries. A discount rate of 19% was deemed appropriate for valuing Saf-T-Net’s trademarks and was based on the risks associated with the respective royalty savings taking into consideration the Company’s weighted average cost of capital. The Company amortizes the trademarks on a straight-line basis over three years from the acquisition date. Amortization of trademarks is not deductible for tax purposes.

 

Of the total estimated purchase price, approximately $26.0 million has been allocated to goodwill and is not deductible for tax purposes. Goodwill represents factors including expected synergies from combining operations and is the excess of the purchase price of an acquired business over the fair value of the net tangible and intangible assets acquired. Goodwill will not be amortized but instead will be tested for impairment at least annually (or more frequently if indicators of impairment arise). In the event that management determines that the goodwill has become impaired, the Company will incur an accounting charge for the amount of the impairment during the fiscal quarter in which the determination is made.

 

As a result of the Saf-T-Net merger, the Company recorded a net deferred tax liability of approximately $3.2 million in its preliminary purchase price allocation. This balance is comprised of approximately $6.0 million in deferred tax liabilities resulting primarily from the estimated amortization expense of identified intangibles, and approximately $2.8 million in deferred tax assets that relate primarily to federal and state net operating loss carry forwards.

 

Deferred Revenue

 

In connection with the preliminary purchase price allocation, the Company determined the estimated fair value of the support obligation assumed from Saf-T-Net in connection with the merger utilizing a cost build-up approach.

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The cost build-up approach determines fair value by estimating the costs relating to fulfilling the obligation plus a normal profit margin. The sum of the costs and operating profit approximates the amount that the Company would be required to pay a third party to assume the support obligation. The Company based its estimated costs to fulfill the support obligation on Saf-T-Net’s historical direct costs related to providing the support services and correcting any errors in Saf-T-Net’s software products. These estimated costs did not include any costs associated with selling efforts or research and development or the related fulfillment margins on these costs. Profit associated with selling efforts is excluded because Saf-T-Net had concluded the selling effort on the support contracts prior to March 19, 2010. The Company estimated the profit margin to be approximately 24%, which approximates the Company’s operating profit margin to fulfill the obligations. In allocating the purchase price, the Company recorded an adjustment to reduce the carrying value of Saf-T-Net’s March 19, 2010 deferred support revenue by approximately $2.6 million to $2.8 million, which represents the Company’s estimate of the fair value of the support obligation assumed. As former Saf-T-Net customers renew these support contracts, the Company will recognize revenue for the full value of the support contracts over the remaining term of the contracts, the majority of which are one year.

 

Elluminate, Inc.

 

On August 4, 2010, the Company completed a merger with Elluminate, Inc. (“Elluminate”) pursuant to an Arrangement Agreement dated July 2, 2010. Pursuant to the Arrangement Agreement, the Company paid merger consideration of approximately $59.5 million in cash (or $58.4 million net of $1.1 million in cash acquired), excluding transaction costs of approximately $1.0 million, which are reflected in general and administrative expenses in the consolidated statements of operations.

 

Elluminate is a provider of web, audio, video and social networking solutions optimized for teaching, learning and collaboration. The Company believes the merger with Elluminate supports the Company’s long-term strategic direction and the demands for innovative technology in the education industry and will help the Company meet the growing demands of its clients, including the ability to provide synchronous learning and collaboration.

 

Preliminary Purchase Price Allocation

 

The Company has accounted for the merger under the acquisition method of accounting. The total preliminary purchase price was allocated to Elluminate’s net tangible and intangible assets acquired and liabilities assumed based on their estimated fair values as of August 4, 2010. The Company recorded the excess of the purchase price over the net tangible liabilities and identifiable intangible assets as goodwill. The preliminary allocation of the purchase price shown in the table below was based on management’s preliminary valuation of the fair value of tangible and intangible assets acquired and liabilities assumed, which are based on estimates and assumptions that

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

are subject to change. The areas of the purchase price allocation that are not yet finalized relate primarily to income and non-income based taxes. The preliminary estimated purchase price is allocated as follows (in thousands):

 

 

Prior to the end of the measurement period for finalizing the purchase price allocation, if information becomes available which would indicate adjustments are required to the purchase price allocation, such adjustments will be included in the purchase price allocation retrospectively.

 

Of the total estimated purchase price, a preliminary estimate of $6.0 million has been allocated to net tangible liabilities assumed, and $24.2 million has been allocated to definite-lived intangible assets acquired. Definite-lived intangible assets of $24.2 million consist of the value assigned to Elluminate’s customer relationships of $18.2 million, developed and core technology of $3.7 million, and trademarks of $2.3 million.

 

The value assigned to Elluminate’s customer relationships was determined by discounting the estimated cash flows associated with the existing customers as of the date the merger was consummated taking into consideration estimated attrition of the existing customer base. The estimated cash flows were based on revenues for those existing customers net of operating expenses and net of capital charges for other tangible and intangible assets that contribute to the projected cash flow from those customers. The projected revenues were based on assumed revenue growth rates and customer renewal rates. Operating expenses were estimated based on the supporting infrastructure expected to sustain the assumed revenue growth rates. Net capital charges for assets that contribute to projected customer cash flow were based on the estimated fair value of those assets. A discount rate of 16.5% was deemed appropriate for valuing the existing customer base and was based on the risks associated with the respective cash flows taking into consideration the Company’s weighted average cost of capital. The Company amortizes the value of Elluminate’s customer relationships on a straight-line basis over seven years from the acquisition date. Amortization of customer relationships is not deductible for tax purposes.

 

The value assigned to Elluminate’s developed and core technology was determined by discounting the estimated royalty savings associated with an estimated royalty rate for the use of the technology to their present value. Developed and core technology, which consists of products that have reached technological feasibility, includes products in Elluminate’s current product line. The royalty rates used to value the technology were based on estimates of prevailing royalty rates paid for the use of similar technology and technology in market transactions involving licensing arrangements of companies that operate in service-related industries. A discount rate of 16.5% was deemed appropriate for valuing developed and core technology and was based on the risks associated with the respective royalty savings taking into consideration the Company’s weighted average cost of capital. The Company amortizes the developed and core technology on a straight-line basis over three years from the acquisition date. Amortization of developed and core technology is not deductible for tax purposes.

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The value assigned to Elluminate’s trademarks was determined by discounting the estimated royalty savings associated with an estimated royalty rate for the use of the trademarks to their present value. The trademarks consist of Elluminate’s trade name and various trademarks related to its existing product lines. The royalty rates used to value the trademarks were based on estimates of prevailing royalty rates paid for the use of similar trade names and trademarks in market transactions involving licensing arrangements of companies that operate in service-related industries. A discount rate of 16.5% was deemed appropriate for valuing Elluminate’s trademarks and was based on the risks associated with the respective royalty savings taking into consideration the Company’s weighted average cost of capital. The Company amortizes the trademarks on a straight-line basis over three years from the acquisition date. Amortization of trademarks is not deductible for tax purposes.

 

Of the total estimated purchase price, approximately $41.3 million has been allocated to goodwill and is not deductible for tax purposes. Goodwill represents factors including expected synergies from combining operations and is the excess of the purchase price of an acquired business over the fair value of the net tangible and intangible assets acquired and liabilities assumed. Goodwill will not be amortized but instead will be tested for impairment at least annually (or more frequently if indicators of impairment arise). In the event that management determines that the goodwill has become impaired, the Company will incur an accounting charge for the amount of the impairment during the fiscal quarter in which the determination is made.

 

As a result of the acquisition of Elluminate, the Company recorded a net deferred tax liability of approximately $7.3 million in its preliminary purchase price allocation. This balance is comprised of approximately $8.9 million in deferred tax liabilities resulting primarily from the estimated amortization expense of identified intangibles and approximately $1.6 million in deferred tax assets that relate primarily to Canadian tax credits and net operating loss carryforwards.

 

Deferred Revenue

 

In connection with the preliminary purchase price allocation, the Company determined the estimated fair value of the support obligation assumed from Elluminate in connection with the merger utilizing a cost build-up approach. The cost build-up approach determines fair value by estimating the costs relating to fulfilling the obligation plus a normal profit margin. The sum of the costs and operating profit approximates the amount that the Company would be required to pay a third party to assume the support obligation. The Company based its estimated costs to fulfill the support obligation on Elluminate’s historical direct costs related to providing the support services and correcting any errors in Elluminate’s software products. These estimated costs did not include any costs associated with selling efforts or research and development or the related fulfillment margins on these costs. Profit associated with selling efforts is excluded because Elluminate had concluded the selling effort on the support contracts prior to August 4, 2010. The Company estimated the profit margin to be approximately 24%, which approximates the Company’s operating profit margin to fulfill the obligations. In allocating the purchase price, the Company recorded an adjustment to reduce the carrying value of Elluminate’s August 4, 2010 deferred support revenue by approximately $10.2 million to $2.7 million, which represents the Company’s estimate of the fair value of the support obligation assumed. As former Elluminate customers renew these support contracts, the Company will recognize revenue for the full value of the support contracts over the remaining term of the contracts, the majority of which are one year.

 

Wimba, Inc.

 

On August 5, 2010, the Company completed a merger with Wimba, Inc. (“Wimba”) pursuant to an Agreement and Plan of Merger dated July 2, 2010. Pursuant to the Agreement and Plan of Merger, the Company paid merger consideration of approximately $59.6 million in cash (or $57.5 million net of $2.1 million in cash acquired), excluding transaction costs of approximately $0.6 million, which are reflected in general and administrative expenses in the consolidated statements of operations.

 

Wimba is a provider of collaborative learning software applications and services to the education industry. The Company believes the merger with Wimba supports the Company’s long-term strategic direction and the demands

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

for innovative technology in the education industry and will help the Company meet the growing demands of its clients, including the ability to provide synchronous learning and collaboration.

 

Preliminary Purchase Price Allocation

 

The Company has accounted for the merger under the acquisition method of accounting. The total preliminary purchase price was allocated to Wimba’s net tangible and intangible assets acquired and liabilities assumed based on their estimated fair values as of August 5, 2010. The Company recorded the excess of the purchase price over the net tangible assets and identifiable intangible assets as goodwill. The preliminary allocation of the purchase price shown in the table below was based on management’s preliminary valuation of the fair value of tangible and intangible assets acquired and liabilities assumed, which are based on estimates and assumptions that are subject to change. The areas of the purchase price allocation that are not yet finalized relate primarily to income and non-income based taxes. The preliminary estimated purchase price is allocated as follows (in thousands):

 

 

Prior to the end of the measurement period for finalizing the purchase price allocation, if information becomes available which would indicate adjustments are required to the purchase price allocation, such adjustments will be included in the purchase price allocation retrospectively.

 

Of the total estimated purchase price, a preliminary estimate of $10.4 million has been allocated to net tangible assets acquired, and $15.4 million has been allocated to definite-lived intangible assets acquired. Definite-lived intangible assets of $15.4 million consist of the value assigned to Wimba’s customer relationships of $12.3 million, developed and core technology of $1.8 million, and trademarks of $1.3 million.

 

The value assigned to Wimba’s customer relationships was determined by discounting the estimated cash flows associated with the existing customers as of the date the merger was consummated taking into consideration estimated attrition of the existing customer base. The estimated cash flows were based on revenues for those existing customers net of operating expenses and net of capital charges for other tangible and intangible assets that contribute to the projected cash flow from those customers. The projected revenues were based on assumed revenue growth rates and customer renewal rates. Operating expenses were estimated based on the supporting infrastructure expected to sustain the assumed revenue growth rates. Net capital charges for assets that contribute to projected customer cash flow were based on the estimated fair value of those assets. A discount rate of 16.5% was deemed appropriate for valuing the existing customer base and was based on the risks associated with the respective cash flows taking into consideration the Company’s weighted average cost of capital. The Company amortizes the value of Wimba’s customer relationships on a straight-line basis over seven years from the acquisition date. Amortization of customer relationships is not deductible for tax purposes.

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The value assigned to Wimba’s developed and core technology was determined by discounting the estimated royalty savings associated with an estimated royalty rate for the use of the technology to their present value. Developed and core technology, which consists of products that have reached technological feasibility, includes products in Wimba’s current product line. The royalty rates used to value the technology were based on estimates of prevailing royalty rates paid for the use of similar technology and technology in market transactions involving licensing arrangements of companies that operate in service-related industries. A discount rate of 16.0% was deemed appropriate for valuing developed and core technology and was based on the risks associated with the respective royalty savings taking into consideration the Company’s weighted average cost of capital. The Company amortizes the developed and core technology on a straight-line basis over three years from the acquisition date. Amortization of developed and core technology is not deductible for tax purposes.

 

The value assigned to Wimba’s trademarks was determined by discounting the estimated royalty savings associated with an estimated royalty rate for the use of the trademarks to their present value. The trademarks consist of Wimba’s trade name and various trademarks related to its existing product lines. The royalty rates used to value the trademarks were based on estimates of prevailing royalty rates paid for the use of similar trade names and trademarks in market transactions involving licensing arrangements of companies that operate in service-related industries. A discount rate of 16.0% was deemed appropriate for valuing Wimba’s trademarks and was based on the risks associated with the respective royalty savings taking into consideration the Company’s weighted average cost of capital. The Company amortizes the trademarks on a straight-line basis over three years from the acquisition date. Amortization of trademarks is not deductible for tax purposes.

 

Of the total estimated purchase price, approximately $33.7 million has been allocated to goodwill and is not deductible for tax purposes. Goodwill represents factors including expected synergies from combining operations and is the excess of the purchase price of an acquired business over the fair value of the net tangible and intangible assets acquired. Goodwill will not be amortized but instead will be tested for impairment at least annually (or more frequently if indicators of impairment arise). In the event that management determines that the goodwill has become impaired, the Company will incur an accounting charge for the amount of the impairment during the fiscal quarter in which the determination is made.

 

As a result of the acquisition of Wimba, the Company recorded a net deferred tax asset of approximately $7.1 million in its preliminary purchase price allocation. This balance is comprised of approximately $13.1 million in deferred tax assets that relate primarily to federal and state net operating loss carry forwards and approximately $6.0 million in deferred tax liabilities resulting primarily from the estimated amortization expense of identified intangibles.

 

Deferred Revenue

 

In connection with the preliminary purchase price allocation, the Company determined the estimated fair value of the support obligation assumed from Wimba in connection with the merger utilizing a cost build-up approach. The cost build-up approach determines fair value by estimating the costs relating to fulfilling the obligation plus a normal profit margin. The sum of the costs and operating profit approximates the amount that the Company would be required to pay a third party to assume the support obligation. The Company based its estimated costs to fulfill the support obligation on Wimba’s historical direct costs related to providing the support services and correcting any errors in Wimba’s software products. These estimated costs did not include any costs associated with selling efforts or research and development or the related fulfillment margins on these costs. Profit associated with selling efforts is excluded because Wimba had concluded the selling effort on the support contracts prior to August 5, 2010. The Company estimated the profit margin to be approximately 24%, which approximates the Company’s operating profit margin to fulfill the obligations. In allocating the purchase price, the Company recorded an adjustment to reduce the carrying value of Wimba’s August 5, 2010 deferred support revenue by approximately $6.9 million to $3.5 million, which represents the Company’s estimate of the fair value of the support obligation assumed. As former Wimba customers renew these support contracts, the Company will recognize revenue for the full value of the support contracts over the remaining term of the contracts, the majority of which are one year.

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

ANGEL Learning, Inc. Merger

 

On May 8, 2009, the Company completed its merger with ANGEL Learning, Inc. (“ANGEL”) pursuant to the Agreement and Plan of Merger dated May 1, 2009. Pursuant to the Agreement and Plan of Merger, the Company paid merger consideration of $101.3 million, which includes $87.4 million in cash and $13.9 million in shares of the Company’s common stock, or approximately 0.5 million shares of common stock. The effective cash portion of the purchase price of ANGEL before transaction costs was approximately $80.8 million, net of ANGEL’s May 8, 2009 cash balance of approximately $6.6 million. The Company has included the financial results of ANGEL in its consolidated financial statements beginning May 9, 2009.

 

Pro Forma Financial Information

 

The unaudited financial information in the table below summarizes the combined results of operations of the Company, Saf-T-Net, Elluminate and Wimba on a pro forma basis, as though the companies had been combined as of the beginning of each of the periods presented. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the mergers had taken place at the beginning of each of the periods presented. The pro forma financial information for all periods presented also includes amortization expense from acquired intangible assets, adjustments to interest expense, interest income and related tax effects.

 

The unaudited pro forma financial information for the three months ended September 30, 2010 combines the historical results for the Company for the three months ended September 30, 2010, the historical results for Elluminate for the period from July 1, 2010 to August 4, 2010 and the historical results for Wimba for the period from July 1, 2010 to August 5, 2010. The unaudited pro forma financial information for the nine months ended September 30, 2010 combines the historical results for the Company for the nine months ended September 30, 2010, the historical results for Saf-T-Net for the period from January 1, 2010 to March 19, 2010, the historical results for Elluminate for the period from January 1, 2010 to August 4, 2010 and the historical results for Wimba for the period from January 1, 2010 to August 5, 2010. The unaudited pro forma financial information for the three and nine months ended September 30, 2009 combines the historical results for the Company for the three and nine months ended September 30, 2009 and the historical results for Saf-T-Net, Elluminate and Wimba for the same period and also gives effect to the Company’s merger with ANGEL on May 8, 2009 as if all transactions had occurred on January 1, 2009. The consolidated financial results for the Company for the three months ended September 30, 2010 include revenue and net income for Saf-T-Net for the period from July 1, 2010 to September 30, 2010 of $2.7 million and $0.6 million, respectively. The consolidated financial results for the Company for the nine months ended September 30, 2010 include revenue and net loss for Saf-T-Net for the period from March 20, 2010 to September 30, 2010 of $4.7 million and $0.4 million, respectively. The consolidated financial results for the Company for the three and nine months ended September 30, 2010 include revenue and net loss for Elluminate for the period from August 5, 2010 to September 30, 2010 of $1.0 million and $3.7 million, respectively. The consolidated financial results for the Company for the three and nine months ended September 30, 2010 include revenue and net loss for Wimba for the period from August 6, 2010 to September 30, 2010 of $1.0 million and $2.5 million, respectively.

 

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Stock Incentive Plans

 

In June 2010, the Company’s stockholders approved an increase in the total number of shares of common stock issuable under the Company’s Amended and Restated 2004 Stock Incentive Plan (the “2004 Plan”) from 10,500,000 to 12,000,000. As of September 30, 2010, approximately 4.5 million shares of common stock were available for future grants under the 2004 Plan and no options were available for future grants under the Company’s Amended and Restated Stock Incentive Plan adopted in 1998. Awards granted under the 2004 Plan generally vest over a three to four-year period and have an eight to ten-year expiration period.

 

The compensation cost that has been recognized in the unaudited consolidated statements of operations for the Company’s stock incentive plans was $12.0 million and $14.9 million for the nine months ended September 30, 2009 and 2010, respectively. The total excess tax benefits recognized for stock-based compensation arrangements was $0.8 million and $2.8 million for the nine months ended September 30, 2009 and 2010, respectively and are classified as a financing cash inflow with a corresponding operating cash outflow. For stock subject to graded vesting, the Company uses the straight-line method for allocating compensation expense by period.

 

Stock Options

 

A summary of stock option activity under the Company’s stock incentive plans as of September 30, 2010, and changes during the nine months then ended are as follows (aggregate intrinsic value in thousands):

 

 

The weighted average remaining contractual lives for all options outstanding under the Company’s stock incentive plans at September 30, 2009 and 2010 were 5.6 and 5.7 years, respectively. The weighted average remaining contractual lives for exercisable stock options at September 30, 2009 and 2010 were 4.7 and 4.8 years, respectively. As of September 30, 2010, there was approximately $30.1 million of total unrecognized compensation cost related to outstanding but unvested stock options. The cost is expected to be recognized through September 2014 with a weighted average recognition period of approximately 1.4 years.

 

The Company recognizes compensation expense for share-based awards based on estimated fair values on the date of grant. The weighted average fair value of the options at the date of grant for the nine months ended September 30, 2009 and 2010 was $12.37 and $15.60, respectively. The fair value of options that vested during the nine months ended September 30, 2009 and 2010 was $10.5 million and $12.2 million, respectively. The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model with the following

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

weighted-average assumptions for stock options granted during the three and nine months ended September 30, 2009 and 2010:

 

 

Dividend yield — The Company has never declared or paid dividends on its common stock and does not anticipate paying dividends in the foreseeable future.

 

Expected volatility — Volatility is a measure of the amount by which a financial variable such as a share price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. The Company uses the daily historical volatility of its stock price over the expected life of the options to calculate the expected volatility.

 

Risk-free interest rate — The average U.S. Treasury rate (for a term that most closely approximates the expected life of the option) during the period in which the option was granted.

 

Expected life of the options — The period of time that the equity grants are expected to remain outstanding. For grants that have been exercised, the Company uses actual exercise data to estimate option exercise timing. For grants that have not been exercised, the Company generally uses the midpoint between the end of the vesting period and the contractual life of the grant to estimate option exercise timing. Options granted during the three and nine months ended September 30, 2009 and 2010 have a maximum term of eight years.

 

Forfeiture rate — The estimated percentage of equity grants that are expected to be forfeited or cancelled on an annual basis before becoming fully vested. The Company estimates the forfeiture rate based on past turnover data, level of employee receiving the equity grant and vesting terms and revises the rate if subsequent information, such as the passage of time, indicates that the actual number of options that will vest is likely to differ from previous estimates. The cumulative effect on current and prior periods of a change in the estimated number of options likely to vest is recognized in compensation cost in the period of the change.

 

Restricted Stock and Restricted Stock Units

 

Restricted stock is a stock award subject to a risk of forfeiture that entitles the holder to receive shares of the Company’s common stock as the award vests over time. A restricted stock unit is a stock award that entitles the holder to receive shares of the Company’s common stock after a vesting requirement is satisfied. The Company estimates the fair value of each restricted stock award and restricted stock unit award using the intrinsic value method which is based on the closing price of the common stock on the date of grant. The Company recognizes compensation expense for restricted stock and restricted stock unit awards over the vesting period on a straight-line basis.

 

As of September 30, 2010, there was approximately $18.7 million of total unrecognized compensation cost related to outstanding but unvested restricted stock and restricted stock unit awards. The cost is expected to be recognized through December 2015 with a weighted average recognition period of approximately 2.2 years.

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

A summary of restricted stock and restricted stock unit activity under the Company’s stock incentive plans as of September 30, 2010, and changes during the nine months then ended are as follows (aggregate intrinsic value in thousands):

 

 

 

The carrying amounts of inventories as of December 31, 2009 and September 30, 2010 are as follows:

 

 

 

Goodwill and intangible assets consist of the following:

 

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Intangible assets from acquisitions are generally amortized over one to seven years. Amortization expense related to intangible assets was approximately $25.7 million and $28.0 million for the nine months ended September 30, 2009 and 2010, respectively. Amortization expense for the years ended December 31, 2010, 2011, 2012, 2013 and 2014 is expected to be approximately $38.3 million, $28.3 million, $24.3 million, $14.7 million and $8.5 million, respectively.

 

During the nine months ended September 30, 2010, the Company invested in the acquisition of intangible assets, which will be amortized over ten years and eight months.

 

 

Convertible Senior Notes

 

In June 2007, the Company issued and sold $165.0 million aggregate principal amount of 3.25% Convertible Senior Notes due 2027 (the “Notes”) in a public offering. The Notes bear interest at a rate of 3.25% per year on the principal amount, accruing from June 20, 2007. Interest is payable semi-annually on January 1 and July 1. The Company made interest payments of $2.7 million on each of June 30, 2009, December 31, 2009 and July 1, 2010. The Notes will mature on July 1, 2027, subject to earlier conversion, redemption or repurchase.

 

The liability and equity components of the Notes are separately accounted for in a manner that reflects the Company’s nonconvertible debt borrowing rate because their terms include partial cash settlement. The Company amortizes the resulting debt discount over the period the convertible debt is expected to be outstanding as additional non-cash interest expense. The Company has determined that its nonconvertible borrowing rate at the time the Notes were issued was 6.9%. Accordingly, the Company estimated the fair value of the liability (debt) component as $144.1 million upon issuance of the Notes. The Company allocated the excess of the proceeds received over the estimated fair value of the liability component totaling $20.9 million to the conversion (equity) component. The carrying amount of the equity component of the Notes was $8.2 million and $4.1 million at December 31, 2009 and September 30, 2010, respectively, and is recorded as a debt discount and is netted against the remaining principal amount outstanding on the Company’s unaudited consolidated balance sheets.

 

In connection with obtaining the Notes, the Company incurred $4.5 million in debt issuance costs, of which $4.0 million was allocated to the liability component and $0.5 million was allocated to the equity component. The carrying amount of the liability component of the debt issuance costs was $0.6 million and $0.1 million at December 31, 2009 and September 30, 2010, respectively, and is recorded as a debt discount and is netted against the remaining principal amount outstanding on the Company’s unaudited consolidated balance sheets.

 

The debt discount, which includes the equity component and the liability component of the debt issuance costs, is being amortized as interest expense using the effective interest method through July 1, 2011, the first redemption date of the Notes. The Company recorded total interest expense of approximately $2.9 million for each of the three months ended September 30, 2009 and 2010, which consisted of $1.3 million in interest expense at a rate of 3.25% per year and $1.6 million in amortization of the debt discount. The Company recorded total interest expense of approximately $8.8 million and $8.7 million for the nine months ended September 30, 2009 and 2010, respectively, which consisted of $4.0 million in interest expense at a rate of 3.25% per year and $4.8 million and $4.7 million in amortization of the debt discount for the nine months ended September 30, 2009 and 2010, respectively.

 

The principal amount of the liability component of the Notes was $165.0 million at each of December 31, 2009 and September 30, 2010. The unamortized debt discount was $8.8 million and $4.2 million at December 31, 2009 and September 30, 2010, respectively. The net carrying amount of the liability component of the Notes was $156.2 million and $160.8 million at December 31, 2009 and September 30, 2010, respectively. As the first redemption date of the Notes is July 1, 2011, the Company reclassified the net carrying amount of the liability component to current liabilities in the unaudited consolidated balance sheet as of September 30, 2010.

 

The Company has evaluated whether certain features of the Notes cause the Notes to be considered to be indexed to the Company’s own stock using a two-step approach to evaluate the Notes’ contingent exercise and

BLACKBOARD INC.

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

settlement provisions. The Company has determined that the Notes’ embedded conversion options are indexed to the Company’s own stock and, therefore, do not require bifurcation and separate accounting.

 

Revolving Credit Facility

 

On August 4, 2010, the Company entered into a five-year $175.0 million senior secured revolving credit facility agreement with a syndicate of banks led by JPMorgan Chase Bank, N.A. as administrative agent, which is available until August 4, 2015 (the “Credit Agreement”). Borrowings under the Credit Agreement are available for general corporate purposes which may include outstanding debt repayments and acquisitions. Loans under the Credit Agreement bear interest at a rate per annum equal to, at the election of the Company, (i) the Adjusted LIBO Rate (as defined in the Credit Agreement) plus a margin which will vary between 2.25% and 3.00% based on the Company’s Leverage Ratio (as defined in the Credit Agreement) or (ii) an Alternate Base Rate (as defined in the Credit Agreement) plus a margin which will vary between 1.25% and 2.00% based on the Company’s Leverage Ratio. Overdue amounts under the Credit Agreement bear interest at a rate per annum equal to 2% plus the rate otherwise applicable to such loan.

 

The Company is required to pay a commitment fee at a rate per annum which will vary between 0.30% and 0.50% based on the Company’s Leverage Ratio on the average daily unused amount of the credit facility commitments during the period for which payment is made, payable quarterly in arrears. The Company records this fee in interest expense. The Company may optionally prepay loans or reduce the credit facility commitments at any time, without penalty.

 

In connection with obtaining the senior secured credit facility, the Company incurred $1.7 million in debt issuance costs in August 2010, which is amortized as interest expense over the term of the senior secured credit facility using the effective interest method. The Company recorded total interest expense of approximately $0.1 million, for the three and nine months ended September 30, 2010.

 

Under the terms of the Credit Agreement and related loan documents, the loans and other obligations of the Company are guaranteed by the material domestic subsidiaries of the Company, and are secured by substantially all of the tangible and intangible assets of the Company and each material domestic subsidiary guarantor (including, without limitation, intellectual property and the capital stock of certain subsidiaries). In addition, the Credit Agreement contains customary affirmative and negative covenants applicable to the Company and its subsidiaries with respect to its operations and financial conditions, including a leverage ratio, a senior leverage ratio, an interest coverage ratio and a minimum liquidity covenant. The Company continues to be in full compliance with all covenants contained in the Credit Agreement.

 

As of September 30, 2010 and November 5, 2010, no amounts were outstanding under the credit facility.

 

 

The Company, from time to time, is subject to litigation relating to matters in the ordinary course of business. The Company believes that any ultimate liability resulting from any such litigation will not have a material adverse effect on the Company’s results of operations, financial position or cash flows.

 

 

The Company’s quarterly operating results normally fluctuate as a result of seasonal variations in its business, principally due to the timing of client budget cycles and student attendance at client facilities. Historically, the Company has had lower new sales in its first and fourth quarters than in the remainder of the year. The Company’s expenses, however, do not vary significantly with these changes, and, as a result, such expenses do not fluctuate significantly on a quarterly basis. Historically, the Company has performed a disproportionate amount of its professional services, for which revenue is recognized as services are performed, in its second and third quarters each year. The Company expects quarterly fluctuations in operating results to continue as a result of the uneven seasonal demand for its licenses and services offerings.

 

This report contains forward-looking statements. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects,” “intends” and similar expressions are intended to identify forward-looking statements. The important factors discussed under the caption “Risk Factors,” presented below, could cause actual results to differ materially from those indicated by forward-looking statements made herein. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

General

 

We are a leading provider of enterprise software applications and related services to the education industry. Our clients use our software to integrate technology into the education experience and campus life, and to support activities such as a professor assigning digital materials on a class website; a student collaborating with peers or completing research online; an administrator managing a departmental website; a superintendant sending mass communications via voice, email and text messages to parents and students; or a merchant conducting cash-free transactions with students and faculty through pre-funded debit accounts. Our clients include colleges, universities, schools and other education providers, textbook publishers, student-focused merchants, and corporate and government clients.

 

We generate revenues from sales and licensing of products and from professional services. Our product revenues consist principally of revenues from annual software licenses, subscription fees from customers accessing our on-demand application services, client hosting engagements and the sale of hardware systems. We typically sell our licenses and hosting services under annually renewable agreements, and our clients generally pay the annual fees at the beginning of the contract term. We recognize revenues from these agreements ratably over the contractual term, which is typically 12 months. We initially record billings associated with licenses and hosting services as deferred revenues and then recognize them ratably into revenues over the contract term. We also generate product revenues from the sale of hardware, including third-party hardware. As a result of new accounting guidance adopted on January 1, 2010, we generally recognize these revenues upon shipment of the products to our clients.

 

We derive professional services revenues primarily from training, implementation, installation and other consulting services. We perform substantially all of our professional services on a time-and-materials basis. We recognize these revenues as the services are performed.

 

We have grown through internal growth and strategic acquisitions. In January 2008, we acquired The NTI Group, Inc., or NTI, and in March 2010, we acquired Saf-T-Net, Inc., or Saf-T-Net. These acquisitions allow us to offer clients the ability to send mass communications via voice, email and text messages. We acquired the technology underlying our Blackboard Connect service, which we began offering in February 2008, from NTI. We acquired the technology underlying the AlertNow service from Saf-T-Net. In May 2009, we acquired ANGEL Learning, Inc., or ANGEL, a leading developer of e-learning software to the U.S. education industry. In July 2009, we acquired the business assets of Terriblyclever Design, LLC, which provides the foundation for the Blackboard Mobile platform. Blackboard Mobile allows us to offer our clients a comprehensive suite of mobile Web applications for education and enables educational institutions to deliver education and campus life services and content to mobile devices to connect students, parents, faculty, prospective students and alumni to the campus experience. In August 2010, we acquired Elluminate Inc., or Elluminate, and Wimba Inc., or Wimba. These acquisitions provide the foundation for our newest platform Blackboard Collaborate, which provides learning software applications for synchronous learning and collaboration.

 

We typically license our individual applications either on a stand-alone basis or bundled as part of one of our five existing platforms: Blackboard Learn^tm; Blackboard Transact^tm; Blackboard Connect^tm; Blackboard Mobile^tm; and Blackboard Collaborate^tm.

 

We offer Blackboard Learn in all of our markets, Blackboard Transact primarily to U.S. and Canadian postsecondary clients, Blackboard Connect to primarily U.S. K-12, postsecondary and government clients,

Blackboard Mobile primarily to U.S. postsecondary and K-12 clients, and Blackboard Collaborate primarily to U.S. and Canadian postsecondary and K-12 clients. We also offer application hosting for clients who prefer to outsource the management of their Blackboard Learn systems. In addition to our products, we offer a variety of professional services, including strategic consulting, project management, custom application development and training.

 

We generally price our software licenses on the basis of full-time equivalent students or users. Accordingly, annual license fees are generally greater for larger institutions.

 

Our operating expenses consist of cost of product revenues, cost of professional services revenues, research and development expenses, sales and marketing expenses, general and administrative expenses and amortization of intangibles resulting from acquisitions.

 

Major components of our cost of product revenues include license and other fees that we owe to third parties upon licensing software, and the cost of hardware that we bundle with our software. As a result of new accounting guidance adopted on January 1, 2010, we generally recognize these costs upon shipment of the products to our clients. In general, prior to the adoption of the new accounting guidance on January 1, 2010 we initially deferred these costs and recognized them into expense over the period in which the related revenue was recognized. Cost of product revenues also includes amortization of internally developed technology available for sale, telecommunications costs related to the Blackboard Connect product, all direct materials and shipping and handling costs, employee compensation, including bonuses, stock-based compensation and benefits for personnel supporting our hosting, support and production functions, as well as related facility rent, communication costs, utilities, depreciation expense and cost of external professional services used in these functions. We expense all of these costs as incurred. Cost of product revenues excludes amortization of acquired technology intangibles resulting from acquisitions, which is separately included on our unaudited consolidated statements of operations as amortization of intangibles acquired in acquisitions. Amortization expense related to acquired technology was $8.2 million and $7.7 million for the nine months ended September 30, 2009 and 2010, respectively.

 

Cost of professional services revenues primarily includes the costs of compensation, including bonuses, stock-based compensation and benefits for employees and external consultants who are involved in the performance of professional services engagements for our clients, as well as travel and related costs, facility rent, communication costs, utilities and depreciation expense used in these functions. We expense all of these costs as incurred.

 

Research and development expenses include the costs of compensation, including bonuses, stock-based compensation and benefits for employees who are associated with the creation and testing of the products we offer, as well as the costs of external professional services, travel and related costs attributable to the creation and testing of our products, related facility rent, communication costs, utilities and depreciation expense used in these functions. We expense all of these costs as incurred.

 

Sales and marketing expenses include the costs of compensation, including bonuses and commissions, stock-based compensation and benefits for employees who are associated with the generation of revenues, as well as marketing expenses, costs of external marketing-related professional services, investor relations, facility rent, utilities, communications, travel attributable to those sales and marketing employees in the generation of revenues and bad debt expense. We expense all of these costs as incurred.

 

General and administrative expenses include the costs of compensation, including bonuses, stock-based compensation and benefits for employees in the human resources, legal, finance and accounting, management information systems, facilities management, executive management and other administrative functions that are not directly associated with the generation of revenues or the creation and testing of products. In addition, general and administrative expenses include the costs of external professional services and insurance, as well as related facility rent, communication costs, utilities and depreciation expense used in these functions. We expense all of these costs as incurred.

 

Amortization of intangibles includes the amortization of costs associated with products, acquired technology, customer lists, non-compete agreements and other identifiable intangible assets. We record these intangible assets at the time of our acquisitions and they relate to contractual agreements, technology and products that we continue to utilize in our business.

Critical Accounting Policies and Estimates

 

The discussion of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. During the preparation of these consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, fair value measures, and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and assumptions, including those related to revenue recognition, bad debts, fixed assets, long-lived assets, including purchase accounting and goodwill, and income taxes. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. The results of our analysis form the basis for making assumptions about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and the impact of such differences may be material to our consolidated financial statements. Our critical accounting policies have been discussed with the audit committee of our board of directors.

 

We believe that the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements. See the information in our filings with the SEC from time to time; including Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009, and our subsequent periodic and current reports, for certain matters that may bear on our results of operations. The following discussion of selected critical accounting policies supplements the information relating to our critical accounting policies described in Part II, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2009.

 

Revenue recognition.  We derive revenues from two sources: product sales and professional services sales. Product revenues include software license fees, subscription fees from customers accessing our on-demand application services, hardware, premium support and maintenance, and hosting revenues. Professional services revenues include revenues from training and consulting services. Our software does not require significant modification and customization services. Where services are not essential to the functionality of the software, we begin to recognize software licensing revenues when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the fee is fixed and determinable; and (4) collectibility is probable.

 

We do not have vendor-specific objective evidence, known as VSOE, of fair value for our support and maintenance separate from our software for the majority of our products. Accordingly, when licenses are sold in conjunction with our support and maintenance, we recognize the license revenue over the term of the maintenance service period. When licenses of certain offerings are sold in conjunction with our support and maintenance where we do have VSOE, we recognize the license revenue upon delivery of the license and recognize the support and maintenance revenue over the term of the maintenance service period.

 

We recognize hosting revenues and set-up fees ratably over the term of the hosting agreement.

 

After any necessary installation services are performed, hardware revenues are recognized when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the fee is fixed and determinable; and (4) collectibility is probable.

 

We early adopted new accounting guidance on January 1, 2010 that impacts our accounting for (a) non-software components of tangible products and (b) software components of tangible products that are sold, licensed, or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s essential functionality. We have applied this guidance on a prospective basis for arrangements executed or significantly modified after December 31, 2009. We allocate the overall consideration from such sales to each deliverable using a best estimate of the selling price of individual deliverables in the arrangement in the absence of VSOE or other third-party evidence of the selling price. Prior to the adoption of this new accounting guidance, in the absence of VSOE, all revenue from such sales was recognized ratably over the term of the applicable maintenance service period.

As a result of the adoption of this new accounting guidance, the product revenues and cost of product revenues related to hardware and software sales in the Blackboard Transact product line will generally be recognized upfront upon delivery of the product to the customer. Product revenues in the Blackboard Transact product line generally consist of hardware, software and support. Generally, the consideration allocated to the hardware and software deliverables is determined using a best estimate of selling price which we estimate based on an analysis of market data and our internal cost to deliver each element. Generally, the consideration allocated to the support deliverable is based on third party evidence. During the three and nine months ended September 30, 2010, we recognized product revenues of approximately $17.8 million and $27.5 million, respectively, under this new accounting guidance, which related to ratable and non-ratable revenue streams and is comprised of arrangements executed or significantly modified after December 31, 2009. In addition, approximately $3.3 million is recorded as deferred revenues on the unaudited consolidated balance sheet as of September 30, 2010 related to these arrangements executed or significantly modified after December 31, 2009. The effect of changes in either selling price or the method or assumptions used to determine selling price for a specific deliverable could have a material effect on the allocation of the overall consideration of an arrangement.

 

As a result of the adoption of this new accounting guidance, revenues, income from operations, net income and basic and diluted earnings per share are approximately $10.4 million, $8.0 million, $5.5 million, $0.16 and $0.16, respectively, higher during the three months ended September 30, 2010 than if we had accounted for these sales under the accounting guidance in effect prior to January 1, 2010. Further, revenues, income from operations, net income and basic and diluted earnings per share are approximately $15.9 million, $12.3 million, $8.5 million, $0.25 and $0.24, respectively, higher during the nine months ended September 30, 2010 than if we had accounted for these sales under the accounting guidance in effect prior to January 1, 2010. We expect the adoption of this new accounting guidance to continue to have a material effect on our consolidated results of operations and financial condition.

 

Our sales arrangements may include professional services sold separately under professional services agreements that include training and consulting services. We account for revenues from these arrangements separately from the license revenue because they meet the criteria for separate accounting. The more significant factors we consider in determining whether revenue should be accounted for separately include the nature of the professional services, such as consideration of whether the professional services are essential to the functionality of the licensed product, degree of risk, availability of professional services from other vendors and timing of payments. We recognize professional services revenues that are sold separately from license revenue as the professional services are performed on a time-and-materials basis.

 

We do not offer specified upgrades or incrementally significant discounts. We record advance payments as deferred revenues until the product is shipped, services are delivered or obligations are met and the revenue can be recognized. Deferred revenues represent the excess of amounts invoiced over amounts recognized as revenues. We provide non-specified upgrades of our product only on a when-and-if-available basis. We account for any contingencies, such as rights of return, conditions of acceptance, warranties and price protection as a separate element. The effect of accounting for these contingencies included in revenue arrangements has not historically been material.

 

Important Factors Considered by Management

 

We consider several factors in evaluating both our financial position and our operating performance. These factors, while primarily focused on relevant financial information, also include other measures such as general market and economic conditions, competitor information and the status of the regulatory environment.

 

To understand our financial results, it is important to understand our business model and its impact on our consolidated financial statements. The accounting for the majority of our contracts requires us to initially record deferred revenues on our consolidated balance sheet upon invoicing the sale and then to recognize revenue in subsequent periods ratably over the term of the contract in our consolidated statements of operations. Therefore, to better understand our operations, one must look at both revenues and deferred revenues.

In evaluating our revenues, we analyze them in two categories: recurring revenues and non-recurring revenues.

 

 

Many of our product revenues are recognized ratably over the contract term, which is typically one year. As a result, in the case of both recurring revenues and non-recurring revenues, an increase or decrease in the revenues in one period may be attributable primarily to increases or decreases in sales in prior periods.

 

Other factors that we consider in making strategic cash flow and operating decisions include cash flows from operations, capital expenditures, total operating expenses and earnings.

 

Our operating results and cash flows normally fluctuate as a result of seasonal variations in our business, principally due to the timing of client budget cycles and student attendance at client facilities. Historically, we have had lower new sales in our first and fourth quarters than in the remainder of the year. Our expenses, however, do not generally vary significantly with these changes on a quarterly basis. Historically, we have performed a disproportionate amount of our professional services, for which revenue is recognized as the services are performed, in our second and third quarters each year. We expect quarterly fluctuations in operating results to continue as a result of the uneven seasonal demand for our licenses and services offerings.

 

Results of Operations

 

The following table sets forth selected unaudited consolidated statement of operations data expressed as a percentage of total revenues for each of the periods indicated.

 

Three Months Ended September 30, 2010 Compared to Three Months Ended September 30, 2009

 

Our total revenues for the three months ended September 30, 2010 were $120.8 million, representing an increase of $22.4 million, or 23%, as compared to $98.4 million for the three months ended September 30, 2009.

 

A detail of our total revenues by classification is as follows:

 

 

Product revenues.  Our product revenues, including domestic and international, for the three months ended September 30, 2010 were $112.3 million, representing an increase of $24.4 million, or 28%, as compared to $87.9 million for the three months ended September 30, 2009. Recurring product revenues increased by $23.8 million, or 31%, for the three months ended September 30, 2010 as compared to the three months ended September 30, 2009. This increase in recurring revenues was primarily due to a $10.4 million increase in revenues recognized from Blackboard Transact due to our early adoption of the change in revenue recognition guidance under which more revenue is recognized upfront. Further, there was a $3.4 million increase in revenues recognized from Blackboard Learn enterprise licenses, which was attributable to current and prior period sales to new and existing clients, the continued shift of our existing clients from Blackboard Learn basic products to Blackboard Learn enterprise products and the cross-selling of other enterprise products to existing clients. Blackboard Learn enterprise products have additional functionality that is not available in Blackboard Learn basic products and consequently some Blackboard Learn basic product clients upgrade to Blackboard Learn enterprise products. Licenses of the enterprise version of Blackboard Learn products have higher average pricing, which normally results in at least twice the contractual value as compared to Blackboard Learn basic product licenses. The remaining increase in recurring product revenues primarily resulted from an increase in Blackboard Mobile revenues of $3.8 million, a $2.2 million increase in revenues for subscription fees from customers accessing our on-demand application services primarily related to Blackboard Connect, a $2.0 million increase resulting from the Elluminate and Wimba mergers that closed in August 2010 and a $1.8 million increase in hosting revenues. The increase in non-recurring product revenues primarily relates to an increase in revenues from Blackboard Transact hardware and third-party hardware sales.

 

Of our total revenues, our total international revenues for the three months ended September 30, 2010 were $19.0 million, representing an increase of $1.4 million, or 8%, as compared to $17.6 million for the three months ended September 30, 2009. International revenues as a percentage of total revenues decreased to 16% for the three months ended September 30, 2010 from 18% for the three months ended September 30, 2009, primarily due to an increase in domestic revenues. International product revenues, which consist primarily of recurring product revenues, were $18.0 million for the three months ended September 30, 2010, representing an increase of $1.5 million, or 9%, as compared to $16.5 million for the three months ended September 30, 2009. The increase in international recurring product revenues was primarily due to an increase in international revenues from Blackboard Learn enterprise products resulting from prior period sales to new and existing clients. In addition, the increase in international revenues also reflects our investment in increasing the size of our international sales force and international marketing efforts during prior periods, which has expanded our international presence and enabled us to sell more of our products to new and existing clients in our international markets.

 

Professional services revenues.  Our professional services revenues for the three months ended September 30, 2010 were $8.5 million, representing a decrease of $2.0 million, or 19%, as compared to $10.5 million for the three months ended September 30, 2009. The decrease in professional services was primarily attributable to the timing of

delivery of service engagements. As a percentage of total revenues, professional services revenues for the three months ended September 30, 2009 and 2010 were 11% and 7%, respectively.

 

Cost of product revenues.  Our cost of product revenues for the three months ended September 30, 2010 was $28.4 million, representing an increase of $4.6 million, or 19%, as compared to $23.8 million for the three months ended September 30, 2009. The increase in cost of product revenues was primarily due to an increase of $1.7 million in expenses related to hosting services due to the increase in the number of clients contracting for new hosting services and existing clients expanding their existing hosting arrangements. In addition, product costs related to Blackboard Transact hardware and third-party hardware sales increased by $2.4 million due to our early adoption of the change in revenue recognition guidance under which more revenue and related costs are recognized upfront. The remaining increase was primarily due to increases in our technical support expenses associated with increased headcount and personnel costs to support an increase in licenses held by new and existing clients. Cost of product revenues as a percentage of product revenues decreased to 25% for the three months ended September 30, 2010 from 27% for the three months ended September 30, 2009.

 

Cost of product revenues excludes amortization of acquired technology intangibles resulting from acquisitions, which is reported separately on our unaudited consolidated statements of operations. Amortization expense related to acquired technology was $2.5 million and $2.3 million for the three months ended September 30, 2009 and 2010, respectively. This decrease was attributable to the completion of the amortization of acquired technology acquired in the ANGEL merger that closed in May 2009, offset, in part, by amortization of acquired technology acquired in the Saf-T-Net merger that closed in March 2010 and the acquisitions of Elluminate and Wimba that closed in August 2010. Cost of product revenues, including amortization of acquired technology, as a percentage of product revenues was 27% for the three months ended September 30, 2010 as compared to 30% for the three months ended September 30, 2009.

 

Cost of professional services revenues.  Our cost of professional services revenues for the three months ended September 30, 2010 was $6.0 million, representing an increase of $0.4 million, or 7%, as compared to $5.6 million for the three months ended September 30, 2009. The increase in the cost of professional services revenues was primarily attributable to an increase in personnel-related costs associated with professional services revenues from new professional service engagements in current and prior periods. Cost of professional services revenues as a percentage of professional services revenues increased to 71% for the three months ended September 30, 2010 from 53% for the three months ended September 30, 2009.

 

Research and development expenses.  Our research and development expenses for the three months ended September 30, 2010 were $15.1 million, representing an increase of $3.7 million, or 32%, as compared to $11.4 million for the three months ended September 30, 2009. This increase was primarily attributable to increased personnel-related costs due to higher average headcount during the three months ended September 30, 2010 as compared to the three months ended September 30, 2009, including increased personnel-related costs associated with the inclusion of Saf-T-Net following the merger that closed in March 2010 and Elluminate and Wimba following the mergers that closed in August 2010.

 

Sales and marketing expenses.  Our sales and marketing expenses for the three months ended September 30, 2010 were $32.6 million, representing an increase of $7.9 million, or 32%, as compared to $24.7 million for the three months ended September 30, 2009. This increase was primarily attributable to increased personnel-related costs due to higher average headcount during the three months ended September 30, 2010 as compared to the three months ended September 30, 2009, including increased personnel-related costs associated with the inclusion of Saf-T-Net following the merger that closed in March 2010 and Elluminate and Wimba following the mergers that closed in August 2010.

 

General and administrative expenses.  Our general and administrative expenses for the three months ended September 30, 2010 were $18.1 million, representing an increase of $3.5 million, or 24%, as compared to $14.6 million for the three months ended September 30, 2009. This increase was primarily attributable to increased personnel-related costs due to higher average headcount during the three months ended September 30, 2010 as compared to the three months ended September 30, 2009, including increased personnel-related costs associated with the inclusion of Saf-T-Net following the merger that closed in March 2010 and Elluminate and Wimba following the mergers that closed in August 2010. The increase in general and administrative expenses was also

attributable to transaction costs of approximately $0.6 million related to the Elluminate and Wimba acquisitions that were incurred during the three months ended September 30, 2010.

 

Amortization of intangibles resulting from acquisitions.  Our amortization of intangibles resulting from acquisitions for the three months ended September 30, 2010 were $9.7 million, representing an increase of $0.4 million, or 4%, as compared to $9.3 million for the three months ended September 30, 2009. This increase was attributable to amortization of certain intangible assets acquired following the Saf-T-Net merger that closed in March 2010 and the Elluminate and Wimba acquisitions that closed in August 2010.

 

Net interest expense.  Our net interest expense for the three months ended September 30, 2010 was $3.1 million, representing an increase of $0.1 million, or 3%, as compared to $3.0 million for the three months ended September 30, 2009. Our net interest expense is primarily the result of the interest expense incurred on our convertible senior notes and the increase was due to recognition of costs associated with our revolving credit facility.

 

Other income (expense).  Our other income for the three months ended September 30, 2010 was $0.4 million, representing an increase of $0.1 million, as compared to $0.3 million for the three months ended September 30, 2009. This increase was related to the remeasurement of our foreign subsidiaries’ ledgers that are denominated in the respective subsidiary’s local currency, into U.S. dollars.

 

Provision for income taxes.  Our provision for income taxes for the three months ended September 30, 2010 was $2.5 million, representing an increase of $0.5 million, or 25%, as compared to $2.0 million for the three months ended September 30, 2009. This change was primarily due to an increase in our income before provision for income taxes for the three months ended September 30, 2010, as compared to the three months ended September 30, 2009.

 

Nine Months Ended September 30, 2010 Compared to Nine Months Ended September 30, 2009

 

Our total revenues for the nine months ended September 30, 2010 were $329.6 million, representing an increase of $52.6 million, or 19%, as compared to $277.0 million for the nine months ended September 30, 2009.

 

A detail of our total revenues by classification is as follows:

 

 

Product revenues.  Our product revenues, including domestic and international, for the nine months ended September 30, 2010 were $303.5 million, representing an increase of $52.1 million, or 21%, as compared to $251.4 million for the nine months ended September 30, 2009. Recurring product revenues increased by $44.2 million, or 20%, for the nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009. This increase in recurring revenues was primarily due to a $15.9 million increase in revenues recognized from Blackboard Transact due to our early adoption of the change in revenue recognition guidance under which more revenue is recognized upfront. Further, there was a $14.8 million increase in revenues recognized from Blackboard Learn enterprise licenses, which was attributable to current and prior period sales to new and existing clients, the continued shift of our existing clients from Blackboard Learn basic products to Blackboard Learn enterprise products and the cross-selling of other enterprise products to existing clients. Blackboard Learn enterprise products have additional functionality that is not available in Blackboard Learn basic products and consequently some Blackboard Learn basic product clients upgrade to Blackboard Learn enterprise products. Licenses of the enterprise version of Blackboard Learn products have higher average pricing, which normally results in at least twice the contractual value as compared to Blackboard Learn basic product licenses. The

remaining increase in recurring product revenues primarily resulted from a $8.5 million increase in hosting revenues, an increase in Blackboard Mobile revenues of $3.8 million and a $2.0 million increase resulting from the Elluminate and Wimba mergers that closed in August 2010. The increase in non-recurring product revenues primarily relates to an increase in revenues from Blackboard Transact hardware and third-party hardware sales.

 

Of our total revenues, our total international revenues for the nine months ended September 30, 2010 were $56.6 million, representing an increase of $5.1 million, or 10%, as compared to $51.5 million for the nine months ended September 30, 2009. International revenues as a percentage of total revenues decreased to 17% for the nine months ended September 30, 2010 from 19% for the nine months ended September 30, 2009, primarily due to an increase in domestic revenues. International product revenues, which consist primarily of recurring product revenues, were $53.3 million for the nine months ended September 30, 2010, representing an increase of $5.5 million, or 12%, as compared to $47.8 million for the nine months ended September 30, 2009. The increase in international recurring product revenues was primarily due to an increase in international revenues from Blackboard Learn enterprise products resulting from prior period sales to new and existing clients. In addition, the increase in international revenues also reflects our investment in increasing the size of our international sales force and international marketing efforts during prior periods, which has expanded our international presence and enabled us to sell more of our products to new and existing clients in our international markets.

 

Professional services revenues.  Our professional services revenues for the nine months ended September 30, 2010 were $26.1 million, representing an increase of $0.5 million, or 2%, as compared to $25.6 million for the nine months ended September 30, 2009. The increase in professional services was primarily attributable to increased sales of consulting services. As a percentage of total revenues, professional services revenues for the nine months ended September 30, 2009 and 2010 were 9% and 8%, respectively.

 

Cost of product revenues.  Our cost of product revenues for the nine months ended September 30, 2010 was $80.4 million, representing an increase of $13.3 million, or 20%, as compared to $67.1 million for the nine months ended September 30, 2009. The increase in cost of product revenues was primarily due to an increase of $5.9 million in expenses related to hosting services due to the increase in the number of clients contracting for new hosting services and existing clients expanding their existing hosting arrangements. In addition, product costs related to Blackboard Transact hardware and third-party hardware sales increased by $5.4 million due primarily to our early adoption of the change in revenue recognition guidance under which more revenue and related costs are recognized upfront. The remaining increase was primarily due to increases in our technical support expenses associated with increased headcount and personnel costs to support an increase in licenses held by new and existing clients. Cost of product revenues as a percentage of product revenues decreased to 26% for the nine months ended September 30, 2010 from 27% for the nine months ended September 30, 2009.

 

Cost of product revenues excludes amortization of acquired technology intangibles resulting from acquisitions, which is reported separately on our unaudited consolidated statements of operations. Amortization expense related to acquired technology was $8.2 million and $7.7 million for the nine months ended September 30, 2009 and 2010, respectively. This decrease was attributable to the completion of the amortization of acquired technology acquired in our acquisition of WebCT in 2006 and the ANGEL merger that closed in May 2009, offset, in part, due to amortization of acquired technology acquired in the Saf-T-Net merger that closed in March 2010 and the acquisitions of Elluminate and Wimba that closed in August 2010. Cost of product revenues, including amortization of acquired technology, as a percentage of product revenues was 29% for the nine months ended September 30, 2010 as compared to 30% for the nine months ended September 30, 2009.

 

Cost of professional services revenues.  Our cost of professional services revenues for the nine months ended September 30, 2010 was $15.9 million, representing an increase of $0.9 million, or 6%, as compared to $15.0 million for the nine months ended September 30, 2009. The increase in the cost of professional services revenues was primarily attributable to an increase in personnel-related costs associated with the increase in professional services revenues from new professional service engagements in current and prior periods. Cost of professional services revenues as a percentage of professional services revenues increased to 61% for the nine months ended September 30, 2010 from 59% for the nine months ended September 30, 2009.

 

Research and development expenses.  Our research and development expenses for the nine months ended September 30, 2010 were $39.3 million, representing an increase of $5.5 million, or 16%, as compared to

$33.8 million for the nine months ended September 30, 2009. This increase was primarily attributable to increased personnel-related costs due to higher average headcount during the nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009, including increased personnel-related costs associated with the inclusion of ANGEL following the merger that closed in May 2009, as well as Saf-T-Net following the merger that closed in March 2010 and Elluminate and Wimba following the acquisitions that closed in August 2010.

 

Sales and marketing expenses.  Our sales and marketing expenses for the nine months ended September 30, 2010 were $85.8 million, representing an increase of $11.8 million, or 16%, as compared to $74.0 million for the nine months ended September 30, 2009. This increase was primarily attributable to increased personnel-related costs due to higher average headcount during the nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009, including increased personnel-related costs associated with the inclusion of ANGEL following the merger that closed in May 2009, as well as Saf-T-Net following the merger that closed in March 2010 and Elluminate and Wimba following the acquisitions that closed in August 2010.

 

General and administrative expenses.  Our general and administrative expenses for the nine months ended September 30, 2010 were $49.6 million, representing an increase of $7.1 million, or 17%, as compared to $42.5 million for the nine months ended September 30, 2009. This increase was primarily attributable to increased personnel-related costs due to higher average headcount during the nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009, including increased personnel-related costs associated with the inclusion of ANGEL following the merger that closed in May 2009, as well as Saf-T-Net following the merger that closed in March 2010 and Elluminate and Wimba following the acquisitions that closed in August 2010. The increase in general and administrative expenses was also attributable to transaction costs of approximately $2.1 million related to the Saf-T-Net, Elluminate and Wimba acquisitions that were incurred during the nine months ended September 30, 2010.

 

Patent-related impairment and other costs.  During the nine months ended September 30, 2009, we recorded expenses of approximately $3.5 million related to the reversal of the 2008 judgment in our patent dispute with Desire2Learn, Inc. Additionally, during the nine months ended September 30, 2009, we recorded a non-cash charge of approximately $7.5 million as the result of impairment of capitalized patent costs due to the reversal of the 2008 judgment.

 

Amortization of intangibles resulting from acquisitions.  Our amortization of intangibles resulting from acquisitions for the nine months ended September 30, 2010 were $28.0 million, representing an increase of $2.3 million, or 9%, as compared to $25.7 million for the nine months ended September 30, 2009. This increase was attributable to amortization of certain intangible assets acquired following the ANGEL merger that closed in May 2009, as well as the Saf-T-Net merger that closed in March 2010 and the Elluminate and Wimba acquisitions that closed in August 2010 offset, in part, by the completion of the amortization of intangible assets acquired in connection with our acquisition of WebCT in 2006.

 

Net interest expense.  Our net interest expense for the nine months ended September 30 2010 was $8.9 million, representing an increase of $0.2 million, or 2%, as compared to $8.7 million for the nine months ended September 30, 2009. Our net interest expense is primarily the result of the interest expense incurred on our convertible senior notes and the increase was primarily due to recognition of costs associated with our revolving credit facility.

 

Other income (expense).  Our other expense for the nine months ended September 30, 2010 was $0.5 million, representing a decrease of $1.6 million, as compared to other income of $1.1 million for the nine months ended September 30, 2009. During the nine months ended September 30, 2009, other income of approximately $1.1 million was recorded in our consolidated statements of operations related to the fair value adjustment of the common stock warrant in connection with an equity transaction between this entity and a venture capital firm that occurred in June 2009. The remaining change in other income (expense) is related to the remeasurement of our foreign subsidiaries’ ledgers that are denominated in the respective subsidiary’s local currency, into U.S. dollars.

 

Provision for income taxes.  Our provision for income taxes for the nine months ended September 30, 2010 was $6.1 million, representing an increase of $6.0 million, as compared to $0.1 million for the nine months ended September 30, 2009. This change was primarily due to an increase in our income before provision for income taxes for the nine months ended September 30, 2010, as compared to the nine months ended September 30, 2009.

Liquidity and Capital Resources

 

Changes in Cash and Cash Equivalents

 

Our cash and cash equivalents were $86.4 million at September 30, 2010 as compared to $167.4 million at December 31, 2009. The decrease in cash and cash equivalents was primarily due to the net cash consideration of approximately $150.1 million used for the acquisitions of Saf-T-Net, Elluminate and Wimba, offset by net cash provided by our operating activities of $64.5 million. Our cash and cash equivalents consist of highly liquid investments, which are readily convertible into cash and have original maturities of three months or less.

 

Net cash provided by operating activities was $64.5 million during the nine months ended September 30, 2010 as compared to net cash provided by operating activities of $89.8 million during the nine months ended September 30, 2009. Amortization of intangibles resulting from acquisitions was $28.0 million during the nine months ended September 30, 2010 and related to the amortization of identified intangibles resulting from acquisitions. We recognize revenues on annually renewable agreements, which results in deferred revenues. Deferred revenues increased by $34.9 million during the nine months ended September 30, 2010, net of the impact of acquired deferred revenues related to the acquisitions of Saf-T-Net, Elluminate and Wimba, due to the timing of certain client renewal invoicing and sales to new and existing clients during the current period. This increase in deferred revenues was partially offset by the change in revenue recognition guidance primarily related to our Blackboard Transact product line in which more revenues are recognized upfront. Accounts receivable increased by $57.0 million during the nine months ended September 30, 2010, net of the impact of acquired receivables related to the acquisitions of Saf-T-Net, Elluminate and Wimba, due to the timing of certain client renewal invoicing and sales to new and existing clients during the current period.

 

Net cash used in investing activities was $171.4 million during the nine months ended September 30, 2010 as compared to $108.1 million during the nine months ended September 30, 2009. During the nine months ended September 30, 2010 we paid $34.2 million in net cash consideration for the acquisition of Saf-T-Net, $58.4 million in net cash consideration for the acquisition of Elluminate and $57.5 million in net cash consideration for the acquisition of Wimba. During the nine months ended September 30, 2010, cash expenditures for purchases of property and equipment were $16.3 million, which represents 5% of total revenues for the nine months ended September 30, 2010.

 

Net cash provided by financing activities was $26.0 million during the nine months ended September 30, 2010 as compared to $8.6 million during the nine months ended September 30, 2009. During the nine months ended September 30, 2010, we received $25.1 million in proceeds from the exercise of stock options as compared to $7.7 million during the nine months ended September 30, 2009.

 

Notes Payable

 

In June 2007, we issued and sold $165.0 million aggregate principal amount of 3.25% Convertible Senior Notes due 2027 (the “Notes”) in a public offering. The Notes bear interest at a rate of 3.25% per year on the principal amount. Interest is payable semi-annually on January 1 and July 1. We made interest payments of $2.7 million on each of June 30, 2009, December 31, 2009 and July 1, 2010. The Notes will mature on July 1, 2027, subject to earlier conversion, redemption or repurchase.

 

If a make-whole fundamental change, as defined in the Notes, occurs prior to July 1, 2011, we may be required in certain circumstances to increase the applicable conversion rate for any Notes converted in connection with such fundamental change by a specified number of shares of our common stock. We may not redeem the Notes prior to July 1, 2011. On or after July 1, 2011, we may redeem the Notes, in whole at any time, or in part from time to time, at a redemption price, payable in cash, up to 100% of the principal amount of the Notes plus accrued and unpaid interest, if any. Holders of the Notes may require us to repurchase some or all of the Notes on July 1, 2011, July 1, 2017 and July 1, 2022, or in the event of certain fundamental change transactions, at 100% of the principal amount on the date of repurchase, plus accrued and unpaid interest, if any, payable in cash. If such an event occurs, we would be required to pay the entire outstanding principal amount of $165.0 million in cash, in addition to any other rights that the investors may have under the Notes. As the first redemption date of the Notes is July 1, 2011, we reclassified

the net carrying amount of the liability component of $160.8 million to current liabilities in our unaudited consolidated balance sheet as of September 30, 2010.

 

The Notes are unsecured senior obligations and are effectively subordinated to all of our existing and future senior indebtedness to the extent of the assets securing such debt, and are effectively subordinated to all indebtedness and liabilities of our subsidiaries, including trade payables.

 

Revolving Credit Facility

 

On August 4, 2010, we entered into a five-year $175.0 million senior secured revolving credit facility agreement with a syndicate of banks led by JPMorgan Chase Bank, N.A. as administrative agent (the “Credit Agreement”). Any amounts that we borrow under the Credit Agreement will be due and payable on August 4, 2015. We may optionally prepay amounts borrowed or otherwise reduce the credit facility commitments at any time without penalty. Borrowings under the Credit Agreement are available for general corporate purposes, which may include outstanding debt repayments and acquisitions. Amounts outstanding under the revolving credit facility bear interest at a variable interest rate set forth in the Credit Agreement equal to, at our election, (i) the Adjusted LIBO Rate (as defined in the Credit Agreement) plus a margin which will vary between 2.25% and 3.00% based on our Leverage Ratio (as defined in the Credit Agreement) or (ii) an Alternate Base Rate (as defined in the Credit Agreement) plus a margin which will vary between 1.25% and 2.00% based on our Leverage Ratio. Any overdue amounts under the Credit Agreement will bear interest at a rate per annum equal to 2% plus the rate otherwise applicable to such amount.

 

We are required to pay a commitment fee of between 0.30% and 0.50% of the average unused amount of the credit facility during each quarter. We record this fee in interest expense.

 

In connection with obtaining the senior secured credit facility, we incurred $1.7 million in debt issuance costs in August 2010, which is amortized as interest expense over the term of the senior secured credit facility using the effective interest method.

 

Under the terms of the Credit Agreement and related loan documents, our obligations have been guaranteed by our material domestic subsidiaries, and are secured by substantially all of our tangible and intangible assets and those of each of our material domestic subsidiaries. In addition, the Credit Agreement contains customary affirmative and negative covenants applicable to us and our subsidiaries with respect to our operations and financial conditions, including maximum permissible debt ratios and a minimum liquidity covenant. We continue to be in full compliance with all covenants contained in the Credit Agreement.

 

As of September 30, 2010 and November 5, 2010, no amounts were outstanding under the credit facility.

 

Working Capital Needs

 

We believe that our existing cash and cash equivalents, together with future cash expected to be provided by operating activities and amounts that may be borrowed under our new revolving credit facility, will be sufficient to meet our working capital and capital expenditure needs over at least the next 12 months, as well as sufficient to repurchase some or all of the Notes, if required by the Holders, or, at our discretion, to redeem the Notes. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our marketing and sales activities, the timing and extent of spending to support product development efforts and expansion into new territories, the timing of introductions of new products or services, the timing of enhancements to existing products and services and the timing of capital expenditures. Also, we may make investments in, or acquisitions of, complementary businesses, services or technologies, which could also require us to seek additional equity or debt financing. To the extent that available funds are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financing. Additional funds may not be available on terms favorable to us or at all. From time to time we may use our existing cash to repurchase shares of our common stock, outstanding indebtedness or other outstanding securities. Any such repurchases would depend on market conditions, the market price of our common stock, and management’s assessment of our liquidity and cash flow needs.

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements with unconsolidated entities or related parties, and, accordingly, there are no off-balance sheet risks to our liquidity and capital resources.

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk.

 

Interest income on our cash and cash equivalents is subject to interest rate fluctuations. For the three and nine months ended September 30, 2010, a ten percent increase in interest rates would not have had a material effect on our interest income.

 

We have accounts on our foreign subsidiaries’ ledgers which are maintained in the respective subsidiary’s local currency and remeasured into the U.S. dollar for reporting of our consolidated results. As a result, we are exposed to fluctuations in the exchange rates of various currencies against the U.S. dollar and against the currencies of other countries in which we maintain foreign denominated balances, including the Canadian dollar, Euro, British pound, Japanese yen, Australian dollar and others. Because of such foreign currency exchange rate fluctuations, we recognized other income of $0.4 million and other expense of $0.5 million during the three and nine months ended September 30, 2010, respectively. For the three and nine months ended September 30, 2010, a ten percent adverse change in the prevailing exchange rates as of September 30, 2010 would not have had a material effect on our consolidated results of operations or financial condition.

 

We may be involved in various legal proceedings from time to time incidental to the ordinary conduct of our business. We believe that any ultimate liability resulting from any such litigation will not have a material adverse effect on our results of operations, financial position or cash flows.

 

We describe our business risk factors below. This description includes any material changes to and supersedes the description of the risk factors previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2009 and Part II, Item 1A of our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2010 and June 30, 2010.

 

Challenging economic conditions may adversely affect our business.

 

The economic disruption experienced in the United States and globally since 2008 and any continuing unfavorable economic conditions may affect our sales and renewals of our products and services, and could negatively affect our revenues and our ability to maintain or grow our business. In addition, the instability in the financial markets has resulted in a tightening of the credit markets, which could impair the ability of our customers to obtain credit to finance purchases of our products. Our client base is diverse and each client or potential client faces a unique set of risks. These risks include, for example, the availability of public funds and the possibility of state and local budget cuts, reduced enrollment, or lower revenues, which could lead to a reduction in overall spending, including information technology spending, by our current and potential clients and a corresponding decline in demand for our products and services. A prolonged economic downturn may result in a reduction in overall demand for educational software products and services, which could cause a decline in both new sales and renewals of our existing products and difficulty in establishing a market for our new products and services. In addition, our accounts receivable may increase and the relative aging of our receivables may deteriorate if our clients delay or are unable to make their payments due to the tightening of credit markets and the lack of available funding. A prolonged economic downturn may make it difficult for potential clients to buy our products and might compromise the ability of existing clients to renew their licenses.

 

We could lose revenues if there are changes in the spending policies or budget priorities for government funding of colleges, universities, schools and other education providers.

 

Most of our clients and potential clients are colleges, universities, schools and other education providers who depend substantially on government funding. Accordingly, any general decrease, delay or change in federal, state or local funding for colleges, universities, schools and other education providers could cause our current and potential clients to reduce their purchases of our products and services, to exercise their right to terminate licenses, or to decide not to renew licenses, any of which would cause us to lose revenues. In addition, a specific reduction in governmental funding support for products such as ours would also cause us to lose revenues. In light of the severe economic downturn experienced in the United States and globally since 2008, many of our clients have experienced and may continue to experience budgetary pressures, which may have a negative impact on sales of our products.

 

Our investments in product development and product acquisition may not be successful; if our products do not gain market acceptance, our revenues may decrease and we may not realize a return on such investments.

 

We make substantial investments in improving our products and acquiring products through mergers and acquisitions, and there can be no assurance that our investments will be successful. Our ability to grow our business will be compromised if we do not develop products and services that achieve broad market acceptance with our current and potential clients. We have recently released a new version, Release 9.1, of our Blackboard Learn platform which offers enhanced functionality over prior versions. If clients do not upgrade to the latest version of the Blackboard Learn platform, the functionality of their existing installed versions will not compare as favorably to competing products which may cause a reduction in renewal rates. Further, if the latest version of our software does

not become widely adopted by clients, we may not be able to justify the investments we have made and our financial results will suffer.

 

If our newest products and services, Blackboard Connect, AlertNow, the Blackboard Mobile product line, and the newly acquired Blackboard Collaborate products do not gain widespread market acceptance, our financial results could suffer. We acquired the technology underlying these products and services through a number of strategic acquisitions. Our ability to grow our business will depend, in part, on client acceptance of these products. If we are not successful in gaining market acceptance of these products and services, our revenues may fall below our expectations.

 

We face intense and growing competition, which could result in price reductions, reduced operating margins and loss of market share.

 

We operate in highly competitive markets and generally encounter intense competition to win contracts. If we are unable to successfully compete for new business and license renewals, our revenue growth and operating margins may decline. The markets for online education, transactional, portal, content management, transaction systems and mass notification products are intensely competitive and rapidly changing, and barriers to entry in these markets are relatively low. With the introduction of new technologies and market entrants, we expect competition to intensify in the future. Some of our principal competitors offer their products at a lower price, which has resulted in pricing pressures. Such pricing pressures and increased competition generally could result in reduced sales, reduced margins or the failure of our product and service offerings to achieve or maintain more widespread market acceptance.

 

Our primary competitors for the Blackboard Learn platform are companies and open source projects that provide course management systems, such as Desire2Learn Inc., Jenzabar, Inc., Microsoft, IBM, Oracle, Moodle, Pearson, The Sakai Project, UCompass Educator and WebTycho; learning content management systems, such as Giunti Labs S.r.I. and Concord USA, Inc.; and education enterprise information portal technologies, such as SunGard Higher Education Inc., an operating unit of SunGard Data Systems Inc. We also face competition from clients and potential clients who develop their own applications internally, large diversified software vendors who offer products in numerous markets including the education market and open source software applications. Our competitors for the Blackboard Transact platform include companies that provide transaction systems, security and access systems and off-campus merchant relationship programs. Our competitors for Blackboard Connect include a variety of competitors which provide mass notification technologies including voice, email and text messaging communications. Our competitors for the newly acquired Blackboard Collaborate products include a variety of companies that provide software applications for synchronous learning and similar technology.

 

We may also face competition from potential competitors that are substantially larger than we are and have significantly greater financial, technical and marketing resources, and established, extensive direct and indirect sales and distribution channels. Similarly, our competitors may also be acquired by larger and more well-funded companies which have more resources than our current competitors. These larger companies may be able to respond more quickly to new or emerging technologies and changes in client requirements, or to devote greater resources to the development, promotion and sale of their products than we can. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or prospective clients. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share to our detriment.

 

If potential clients or competitors use open source software to develop products that are competitive with our products and services, we may face decreased demand and pressure to reduce the prices for our products.

 

The growing acceptance and prevalence of open source software may make it easier for competitors or potential competitors to develop software applications that compete with our products, or for clients and potential clients to internally develop software applications that they would otherwise have licensed from us. One of the aspects of open source software is that it can be modified or used to develop new software that competes with proprietary software applications, such as ours. Such competition can develop without the degree of overhead and lead time required by traditional proprietary software companies. As open source offerings become more prevalent,

customers may defer or forego purchases of our products, which could reduce our sales and lengthen the sales cycle for our products or result in the loss of current clients to open source solutions. If we are unable to differentiate our products from competitive products based on open source software, demand for our products and services may decline, and we may face pressure to reduce the prices of our products, which would hurt our profitability.

 

Our recent acquisition transactions present many risks, and we may not realize the financial and strategic goals that were contemplated at the time of the transactions.

 

We have entered into a number of acquisition transactions as part of our growth strategy. We completed acquisitions of ANGEL and the business assets of Terriblyclever Design in 2009 and Saf-T-Net, Elluminate and Wimba in 2010. We have entered into these transactions with the expectation that each would result in long-term benefits, including improved revenue and profits, and enhancements to our product portfolio and customer base. Risks that we may encounter in seeking to realize the benefits of these and other potential acquisition transactions include:

 

 

Our business strategy contemplates future business combinations and acquisitions which may be difficult to integrate, disrupt our business, dilute stockholder value or divert management attention.

 

A key element of our growth strategy is to pursue additional acquisitions in the future. Any acquisition could be expensive, disrupt our ongoing business and distract our management and employees. We may not be able to identify suitable acquisition candidates, and if we do identify suitable candidates, we may not be able to make these acquisitions on acceptable terms or at all. If we make an acquisition, we could have difficulty integrating the acquired technology, employees or operations. In addition, the key personnel of the acquired company may decide not to work for us. Acquisitions also involve the risk of potential unknown liabilities associated with the acquired business.

 

As a result of these risks, we may not be able to achieve the expected benefits of any acquisition. If we are unsuccessful in completing or integrating future acquisitions, we would be required to reevaluate our growth strategy, and we may have incurred substantial expenses and devoted significant management time and resources in seeking to complete and integrate the acquisitions.

 

Future business combinations could involve the acquisition of significant tangible and intangible assets, which could require us to record in our statements of operations ongoing amortization of identified intangible assets acquired in connection with acquisitions, which we currently do with respect to our historical acquisitions, including the NTI, ANGEL, Saf-T-Net, Elluminate and Wimba mergers. In addition, we may need to record write-downs from future impairments of identified tangible and intangible assets and goodwill. These accounting charges would reduce any future reported earnings, or increase a reported loss. In future acquisitions, we could also incur

debt to pay for acquisitions, or issue additional equity securities as consideration, which could cause our stockholders to suffer significant dilution.

 

Additionally, our ability to utilize net operating loss carryforwards, if any, acquired in any acquisitions may be significantly limited or unusable by us under Section 382 or other sections of the Internal Revenue Code.

 

Our indebtedness, and the restrictive covenants contained in our revolving credit facility, could constrict our liquidity, result in substantial cash outflows, and adversely affect our ability to operate our business successfully and to obtain financing in the future.

 

We entered into a five-year $175.0 million senior secured revolving credit facility in August 2010. The credit agreement limits our ability to incur additional indebtedness, create liens, make investments, make restricted payments, and merge, consolidate, sell or acquire assets, among other things. In addition, we are required to comply with certain leverage and other financial maintenance tests. As we borrow amounts under this facility, this debt may impair our ability to obtain future additional financing for working capital, capital expenditures, acquisitions, general corporate or other purposes, and a substantial portion of our cash flows from operations may be dedicated to the debt repayment, thereby reducing the funds available to us for other purposes, which could make us more vulnerable to industry downturns and competitive pressures. Any breach of our covenants set forth in the credit agreement, or our failure to satisfy our obligations with respect to these debt obligations could result in a default under the credit facility, which could result in acceleration of the debt and certain of our other financial obligations. As of September 30, 2010 and November 5, 2010, no amounts were outstanding under the revolving credit facility.

 

Our existing indebtedness could adversely affect our financial condition and we may not be able to fulfill our debt obligations, including repayment of the Notes.

 

The outstanding Notes in the principal amount of $165.0 million pose the following risks to our overall business:

 

 

We may be more vulnerable to adverse economic conditions than less leveraged competitors and thus less able to withstand competitive pressures. Any of these events could reduce our ability to generate cash available for investment or debt repayment or to make improvements or respond to events that would enhance profitability. We may incur significantly more debt in the future, which will increase each of the foregoing risks related to our indebtedness.

 

We may not be able to repurchase the Notes when required by the holders, including upon a defined fundamental change or other specified dates at the option of the holder, or pay cash upon conversion of the Notes.

 

Upon the occurrence of a fundamental change as defined in the Notes, holders of the Notes would have the right to require us to repurchase the Notes at a price in cash equal to 100% of the principal amount of the Notes plus

accrued and unpaid interest. Any future credit agreement or other agreements relating to indebtedness to which we become a party may contain similar provisions. Holders will also have the right to require us to repurchase the Notes for cash or a combination of cash and our common stock on July 1, 2011, July 1, 2017 or July 1, 2022. Moreover, upon conversion of the Notes, we are required to settle a portion of the conversion obligation in cash. In the event that we are required to repurchase the Notes or upon conversion of the Notes, we may not have sufficient financial resources to satisfy all of our obligations under the Notes and our other debt instruments. Our failure to pay the repurchase price when due, to pay cash upon conversion of the Notes, or similarly fail to meet our payment obligations, would result in a default under the indenture governing the Notes.

 

Conversion of the Notes may affect the market price of our common stock and may dilute the ownership of existing stockholders.

 

The conversion of some or all of the Notes and any sales in the public market of our common stock issued upon such conversion could adversely affect the market price of our common stock. The existence of the Notes may encourage short selling by market participants because the conversion of the Notes could depress our common stock price. In addition, the conversion of some or all of the Notes could dilute the ownership interests of existing stockholders to the extent that shares of our common stock are issued upon conversion.

 

Our reported earnings per share may be more volatile because of the contingent conversion provision of the Notes.

 

The Notes may have a dilutive effect on earnings per share in any period in which the market price of our common stock exceeds the conversion price for the Notes as a result of the inclusion of the underlying shares in the fully diluted earnings per share calculation. Volatility in our stock price could cause this condition or other conversion conditions to be met in one quarter and not in a subsequent quarter, increasing the volatility of fully diluted earnings per share.

 

Because most of our licenses are renewable on an annual basis, a reduction in our license renewal rate could significantly reduce our revenues.

 

Our clients have no obligation to renew their licenses for our products after the expiration of the initial license period, which is typically one year, and some clients have elected not to do so. A decline in license renewal rates could cause our revenues to decline. We have limited historical data with respect to rates of renewals, so we cannot accurately predict future renewal rates. Our license renewal rates may decline or fluctuate as a result of a number of factors, including client dissatisfaction with our products and services, our failure to update our products to maintain their attractiveness in the market or budgetary constraints or changes in budget priorities faced by our clients.

 

We may experience difficulties that could delay or prevent the successful development, introduction and sale of new products under development. If introduced for sale, the new products may not adequately meet the requirements of the marketplace and may not achieve any significant degree of market acceptance, which could cause our financial results to suffer. In addition, during the development period for the new products, our customers may defer or forego purchases of our products and services. We often obtain renewable client contracts in acquisitions, and if we experience a decrease in the renewal rate from expected levels it could reduce revenues below our expectations.

 

Because we generally recognize revenues ratably over the term of our contract with a client, downturns or upturns in sales will not be fully reflected in our operating results until future periods.

 

We recognize most of our revenues from clients monthly over the terms of their agreements, which are typically 12 months, although terms can range from one month to over 60 months. As a result, much of the revenue we report in each quarter is attributable to agreements entered into during previous quarters. Consequently, a decline in sales, client renewals, or market acceptance of our products in any one quarter would not necessarily be fully reflected in the revenues in that quarter, and would negatively affect our revenues and profitability in future

quarters. This ratable revenue recognition also makes it difficult for us to rapidly increase our revenues through additional sales in any period, as revenues from new clients must be recognized over the applicable agreement term.

 

Our operating margins may suffer if our professional services revenues increase in proportion to total revenues because our professional services revenues have lower gross margins.

 

Because our professional services revenues typically have lower gross margins than our product revenues, an increase in the percentage of total revenues represented by professional services revenues could have a detrimental impact on our overall gross margins, and could adversely affect our operating results. In addition, we sometimes subcontract professional services to third parties, which further reduces our gross margins on these professional services. As a result, an increase in the percentage of professional services provided by third-party consultants could lower our overall gross margins.

 

If our products contain errors, new product releases are delayed or our services are disrupted, we could lose new sales and be subject to significant liability claims.

 

Because our software products are complex, they may contain undetected errors or defects, known as bugs. Bugs can be detected at any point in a product’s life cycle, but are more common when a new product is introduced or when new versions are released. In the past, we have encountered product development delays and defects in our products. We expect that, despite our testing, errors will be found in new products and product enhancements in the future. In addition, our service offerings may be disrupted causing delays or interruptions in the services provided to our clients. Significant errors in our products or disruptions in the provision of our services could lead to:

 

 

Because our clients use our products to store, retrieve and utilize critical information, we may be subject to significant liability claims if our products do not work properly or if the provision of our services is disrupted. Such an event could result in significant expenses, disrupt sales and affect our reputation and that of our products. We cannot be certain that the limitations of liability set forth in our licenses and agreements would be enforceable or would otherwise protect us from liability for damages and our insurance may not cover all or any of the claims. A material liability claim against us, regardless of its merit or its outcome, could result in substantial costs, significantly harm our business reputation and divert management’s attention from our operations.

 

The length and unpredictability of the sales cycle for our software could delay new sales and cause our revenues and cash flows for any given quarter to fail to meet our projections or market expectations.

 

The sales cycle between our initial contact with a potential client and the signing of a license with that client typically ranges from 6 to 18 months. As a result of this lengthy sales cycle, we have only a limited ability to forecast the timing of sales. A delay in or failure to complete license transactions could harm our business and financial results, and could cause our financial results to vary significantly from quarter to quarter. Our sales cycle varies widely, reflecting differences in our potential clients’ decision-making processes, procurement requirements and budget cycles, and is subject to significant risks over which we have little or no control, including:

 

 

Potential clients typically conduct extensive and lengthy evaluations before committing to our products and services and generally require us to expend substantial time, effort and money educating them as to the value of our offerings. In light of the ongoing economic disruption in the U.S. and globally, we have experienced some lengthening of sales cycles and, depending on the future economic climate, may see a continuation of this trend. Our client base is diverse and each component faces a unique set of risks, including, for example, the possibility of state and local budget cuts for K-12 institutions or reduced enrollment in higher education, which may affect our revenues and our ability to grow our business. If the economic downturn worsens or is prolonged, our clients and prospective clients may defer or cancel their purchases with us.

 

Our sales cycle with international postsecondary education providers and U.S. K-12 schools may be longer than our historical U.S. postsecondary sales cycle, which could cause us to incur greater costs and could reduce our operating margins.

 

As we target more of our sales efforts at international postsecondary education providers and U.S. K-12 schools, we could face greater costs, longer sales cycles and less predictability in completing some of our sales, which may harm our business. A potential client’s decision to use our products and services may be a decision involving multiple institutions and, if so, these types of sales would require us to provide greater levels of education to prospective clients regarding the use and benefits of our products and services. In addition, we expect that potential international postsecondary and U.S. K-12 clients may demand more customization, integration services and features. As a result of these factors, these sales opportunities may require us to devote greater sales support and professional services resources to individual sales, thereby increasing the costs and time required to complete sales and diverting sales and professional services resources to a smaller number of international and U.S. K-12 transactions.

 

We may have exposure to greater than anticipated tax liabilities.

 

We are subject to income taxes and other taxes in a variety of jurisdictions and are subject to review by both domestic and foreign taxation authorities. The determination of our provision for income taxes and other tax liabilities requires significant judgment and the ultimate tax outcome may differ from the amounts recorded in our consolidated financial statements, which may materially affect our financial results in the period or periods for which such determination is made.

 

Our ability to utilize our net operating loss carryforwards may be limited.

 

Our federal net operating loss carryforwards are subject to limitations on how much may be utilized on an annual basis. The use of the net operating loss carryforwards may have additional limitations resulting from future ownership changes or other factors under Section 382 of the Internal Revenue Code.

 

If our net operating loss carryforwards are further limited, and we have taxable income which exceeds the available net operating loss carryforwards for that period, we would incur an income tax liability even though net operating loss carryforwards may be available in future years prior to their expiration. Any such income tax liability may adversely affect our future cash flow, financial position and financial results.

 

The investment of our cash balances are subject to risks that may cause losses and affect the liquidity of these investments.

 

We hold our cash in a variety of marketable investments which are generally investment grade, liquid, short-term securities and money market instruments denominated in U.S. dollars. If the carrying value of our investments exceeds the fair value, and the decline in fair value is deemed to be other-than-temporary, we will be required to further write down the value of our investments, which would be reflected in our statement of operations for that period. With the continued unstable credit environment, we might incur significant realized, unrealized or impairment losses associated with these investments.

Our future success depends on our ability to continue to retain and attract qualified employees.

 

Our future success depends upon the continued service of our key management, technical, sales and other critical personnel, including employees who joined Blackboard in connection with our recent acquisitions. Whether we are able to execute effectively on our business strategy will depend in large part on how well key management and other personnel perform in their positions and are integrated within our company. Key personnel have left our company over the years, including our former Chief Financial Officer during 2010, and there may be additional departures of key personnel from time to time. In addition, as we seek to expand our global organization, the hiring of qualified sales, technical and support personnel has been difficult due to the limited number of qualified professionals. Failure to attract, integrate and retain key personnel would result in disruptions to our operations, including adversely affecting the timeliness of product releases, the successful implementation and completion of company initiatives and the results of our operations.

 

If we do not maintain the compatibility of our products with third-party applications that our clients use in conjunction with our products, demand for our products could decline.

 

Our software applications can be used with a variety of third-party applications used by our clients to extend the functionality of our products, which we believe contributes to the attractiveness of our products in the market. If we are not able to maintain the compatibility of our products with third-party applications, demand for our products could decline, and we could lose sales. We may desire in the future to make our products compatible with new or existing third-party applications that achieve popularity within the education marketplace, and these third-party applications may not be compatible with our designs. Any failure on our part to modify our applications to ensure compatibility with such third-party applications would reduce demand for our products and services.

 

If we are unable to obtain sufficient quantities of the hardware products we sell in a timely manner, our sales could decline.

 

We rely on various third-party companies to provide us with hardware products which we sell to our clients. Such companies include manufacturers of third-party products and manufacturers of Blackboard Transact hardware products to which we have outsourced our manufacturing operations. The failure to obtain sufficient quantities of the products we sell to our clients or any substantial delays or product quality problems associated with our obtaining such products could decrease our sales.

 

If we are unable to protect our proprietary technology and other rights, it will reduce our ability to compete for business.

 

If we are unable to protect our intellectual property, our competitors could use our intellectual property to market products similar to our products, which could decrease demand for our products. In addition, we may be unable to prevent the use of our products by persons who have not paid the required license fee, which could reduce our revenues. We rely on a combination of copyright, patent, trademark and trade secret laws, as well as licensing agreements, third-party nondisclosure agreements and other contractual provisions and technical measures, to protect our intellectual property rights. These protections may not be adequate to prevent our competitors from copying or reverse-engineering our products, and these protections may be costly and difficult to enforce. Our competitors may independently develop technologies that are substantially equivalent or superior to our technology. To protect our trade secrets and other proprietary information, we require employees, consultants, advisors and collaborators to enter into confidentiality agreements. These agreements may not provide meaningful protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information. The protective mechanisms we include in our products may not be sufficient to prevent unauthorized copying. Existing copyright laws afford only limited protection for our intellectual property rights and may not protect such rights in the event competitors independently develop products similar to ours. In addition, the laws of some countries in which our products are or may be licensed do not protect our products and intellectual property rights to the same extent as do the laws of the United States.

If we are found to have infringed the proprietary rights of others, we could be required to redesign our products, pay significant royalties or enter into license agreements with third parties.

 

A third party may assert that our technology violates its intellectual property rights. As the number of products in our markets increases and the functionality of these products further overlaps, we believe that infringement claims may become more common. Any claims, regardless of their merit, could:

 

 

The nature of our business and our reliance on intellectual property and other proprietary information subjects us to the risks of litigation.

 

We are in an industry where litigation is common, including litigation related to copyright, patent, trademark and trade secret rights, and other types of claims. Litigation can be expensive and disruptive to normal business operations. The results of litigation are inherently uncertain and may result in adverse rulings or decisions. We may enter into settlements or be subject to judgments that may result in an obligation to pay significant monetary damages, prevent us from operating one or more elements of our business or otherwise hurt our operations.

 

Expansion of our business internationally will subject our business to additional economic and operational risks that could increase our costs and make it difficult for us to operate profitably.

 

One of our key growth strategies is to pursue international expansion. Expansion of our international operations may require significant expenditure of financial and management resources and result in increased administrative and compliance costs. As a result of such expansion, we will be increasingly subject to the risks inherent in conducting business internationally, including:

 

 

Unauthorized disclosure of data, whether through breach of our computer systems or otherwise, could expose us to protracted and costly litigation or cause us to lose clients.

 

Maintaining the security of our systems is of critical importance for our clients because they may involve the storage and transmission of proprietary and confidential client and student information, including personal student

information and consumer financial data, such as credit card numbers. This area is heavily regulated in many countries in which we operate, including the United States. Individuals and groups may develop and deploy viruses, worms and other malicious software programs that attack or attempt to infiltrate our products. If our security measures are breached as a result of third-party action, employee error, malfeasance or otherwise, we could be subject to liability or our business could be interrupted. Penetration of our network security could have a negative impact on our reputation, could lead our present and potential clients to choose competing offerings, and could result in legal or regulatory action against us. Even if we do not encounter a security breach ourselves, a well-publicized breach of the consumer data security of another company could lead to a general public loss of confidence in the use of our products, which could significantly diminish the attractiveness of our products and services.

 

Operational failures in our network infrastructure could disrupt our remote hosting services, could cause us to lose clients and sales to potential clients and could result in increased expenses and reduced revenues.

 

Unanticipated problems affecting our network systems could cause interruptions or delays in the delivery of the hosting services we provide to some of our clients. We provide remote hosting through computer hardware that is currently located in third-party co-location facilities in various locations in the United States, The Netherlands and Australia. We do not control the operation of these co-location facilities. Lengthy interruptions in our hosting service could be caused by the occurrence of a natural disaster, power loss, vandalism or other telecommunications problems at the co-location facilities or if these co-location facilities were to close without adequate notice. Although we have developed redundancies in some of our systems, we have experienced problems of this nature from time to time in the past, and we will continue to be exposed to the risk of network failures in the future. We currently do not have adequate computer hardware and systems to provide alternative service for most of our hosted clients in the event of an extended loss of service at the co-location facilities. Some of our co-location facilities are served by data backup redundancy at other facilities. However, they are not equipped to provide full disaster recovery to all of our hosted clients. If there are operational failures in our network infrastructure that cause interruptions, slower response times, loss of data or extended loss of service for our remotely hosted clients, we may be required to issue credits or pay penalties, current clients may terminate their contracts or elect not to renew them, and we may lose sales to potential clients. If we determine that we need additional hardware and systems, we may be required to make further investments in our network infrastructure.

 

U.S. and foreign government regulation of our products and services could cause us to incur significant expenses, and failure to comply with applicable regulations could make our business less efficient or even impossible.

 

The application of existing laws and regulations potentially applicable to our products and services, including regulations relating to issues such as privacy, telecommunications, defamation, pricing, advertising, taxation, consumer protection, content regulation, quality of products and services and intellectual property ownership and infringement, can be unclear. It is possible that U.S., state, local and foreign governments might attempt to regulate our products and services or prosecute us for violations of their laws. In addition, these laws may be modified and new laws may be enacted in the future, which could increase the costs of regulatory compliance for us or force us to change our business practices. Any existing or new legislation applicable to us could expose us to substantial liability, including significant expenses necessary to comply with such laws and regulations, and dampen the growth in use of our products and services.

 

We may be subject to state and federal financial services regulation, and any violation of any present or future regulation could expose us to liability, force us to change our business practices or force us to stop selling or modify our products and services.

 

Our transaction processing product and service offering could be subject to state and federal financial services regulation or industry-mandated requirements. The Blackboard Transact platform supports the creation and management of student debit accounts and the processing of payments against those accounts for both on-campus vendors and off-campus merchants. For example, one or more federal or state governmental agencies that regulate or monitor banks or other types of providers of electronic commerce services may conclude that we are engaged in

banking or other financial services activities that are regulated by the Federal Reserve under the U.S. Federal Electronic Funds Transfer Act or Regulation E thereunder or by state agencies under similar state statutes or regulations. Regulatory requirements may include, for example:

 

 

A number of states have enacted legislation regulating check sellers, money transmitters or transaction settlement service providers as banks. If we were deemed to be in violation of any current or future regulations, we could be exposed to financial liability and adverse publicity or forced to change our business practices or stop selling some of our products and services. As a result, we could face significant legal fees, delays in extending our product and services offerings, and damage to our reputation that could harm our business and reduce demand for our products and services. Even if we are not required to change our business practices, we could be required to obtain licenses or regulatory approvals that could cause us to incur substantial costs.

 

(a) Exhibits:

 

 

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Blackboard Inc.

 

John E. Kinzer

Chief Financial Officer

(On behalf of the registrant and as Principal

Financial Officer)

 

Dated: November 5, 2010