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ITEM 7.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
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FORWARD-LOOKING STATEMENTS
This document contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that are not historical in nature and typically address future or anticipated events, trends, expectations or beliefs with respect to our financial condition, results of operations or business. Forward-looking statements often contain words such as “believes,” “expects,” “anticipates,” “foresees,” “forecasts,” “estimates,” “plans,” “intends,” “continues,” “may,” “will,” “should,” “projects,” “might,” “could” or other similar words or phrases. Similarly, statements that describe our business strategy, outlook, objectives, plans, intentions or goals also are forward-looking statements. We believe there is a reasonable basis for our forward-looking statements, but they are inherently subject to risks and uncertainties and actual results could differ materially from the expectations and beliefs reflected in the forward-looking statements. We presently consider the following to be among the important factors that could cause actual results to differ materially from our expectations and beliefs: (1) changes in the budgets or regulatory environments of our clients, primarily local and state governments, that could negatively impact information technology spending; (2) our ability to protect client information from security breaches and provide uninterrupted operations of data centers; (3) our ability to achieve growth or operational synergies through the integration of acquired businesses, while avoiding unanticipated costs and disruptions to existing operations; (4) material portions of our business require the Internet infrastructure to be adequately maintained; (5) our ability to achieve our financial forecasts due to various factors, including project delays by our clients, reductions in transaction size, fewer transactions, delays in delivery of new products or releases or a decline in our renewal rates for service agreements; (6) general economic, political and market conditions; (7) technological and market risks associated with the development of new products or services or of new versions of existing or acquired products or services; (8) competition in the industry in which we conduct business and the impact of competition on pricing, client retention and pressure for new products or services; (9) the ability to attract and retain qualified personnel and dealing with the loss or retirement of key members of management or other key personnel; and (10) costs of compliance and any failure to comply with government and stock exchange regulations. A detailed discussion of these factors and other risks that affect our business are described in Item 1A, “Risk Factors.” We expressly disclaim any obligation to publicly update or revise our forward-looking statements.
OVERVIEW
General
We provide integrated information management solutions and services for the public sector, with a focus on local governments. We develop and market a broad line of software products and services to address the IT needs of cities, counties, schools and other local government entities. In addition, we provide professional IT services to our clients, including software and hardware installation, data conversion, training and for certain clients, product modifications, along with continuing maintenance and support for clients using our systems. We also provide subscription-based services such as software as a service (“SaaS”), which utilizes the Tyler private cloud, and electronic document filing solutions (“e-filing”), which simplify the filing and management of court related documents. Revenues for e-filing are derived from transaction fees and, in some cases, fixed fee arrangements. We also provide property appraisal outsourcing services for taxing jurisdictions.
Our products generally automate six major functional areas: (1) financial management and education, (2) courts and justice, (3) public safety (4) property appraisal and tax, (5) planning, regulatory and maintenance, and (6) land and vital records management. We report our results in two segments. The Enterprise Software (“ES”) segment provides municipal and county governments and schools with software systems and services to meet their information technology and automation needs for mission-critical “back-office” functions such as: financial management; courts and justice processes; public safety; planning, regulatory and maintenance; and land and vital records management. The Appraisal and Tax (“A&T”) segment provides systems and software that automate the appraisal and assessment of real and personal property as well as property appraisal outsourcing services for local governments and taxing authorities. Property appraisal outsourcing services include: the physical inspection of commercial and residential properties; data collection and processing; computer analysis for property valuation; preparation of tax rolls; community education; and arbitration between taxpayers and the assessing jurisdiction.
Total revenues increased
11%
in
2017
compared to
2016
.
Recent Acquisitions
On
November 29, 2017
, we acquired audio and digital two-way radio communications technology and related assets from
Radio 10-33, LLC
an audio and digital two-way radio communications company. The total purchase price was
$1.4 million
.
On
August 2, 2017
, we acquired substantially all of the assets and assumed certain liabilities of
Digital Health Department, Inc.
("DHD"), a company that provides environmental health software, offering a software-as-a-service (SaaS) solution for public health compliance and inspections processes. The total purchase price, net of debt assumed, was
$3.9 million
.
On
May 30, 2017
, we acquired all of the capital stock of
Modria.com, Inc.
, a company that specializes in online dispute resolution for government and commercial entities. The total purchase price, net of debt assumed, was
$7.0 million
.
The operating results of these acquisitions are included in our results of operations of the Enterprise Software segment from the date of the acquisition. The impact of these acquisitions, individually and in the aggregate, on our operating results is not material.
On December 22, 2017, the Tax Act was enacted. The Tax Act amends the Internal Revenue Code to reduce tax rates and modify policies, credits and deductions for individuals and businesses. For businesses, the Tax Act reduces the U.S. corporate federal tax rate from 35% to 21% and transitions from a worldwide tax system to a territorial tax system. The impact of the rate reduction on our 2017 income tax provision is a
$21.6 million
tax benefit due to the remeasurement of deferred tax assets and liabilities. Refer to Note 7 "Income Tax" for further discussion on the impact of the Tax Act.
We monitor and analyze several key performance indicators in order to manage our business and evaluate our financial and operating performance. These indicators include the following:
Revenues – We derive our revenues from five primary sources: sale of software licenses and royalties; subscription-based arrangements; software services; maintenance; and appraisal services. Subscriptions and maintenance are considered recurring revenue sources and comprised approximately
64%
of our revenue in
2017
. The number of new SaaS clients and the number of existing clients who convert from our traditional software arrangements to our SaaS model are a significant driver to our business, together with new software license sales and maintenance rate increases. In addition, we also monitor our customer base and churn as we historically have experienced very low customer turnover. During
2017
, based on our number of customers, turnover was approximately
2%
.
Cost of Revenues and Gross Margins – Our primary cost component is personnel expenses in connection with providing software implementation, subscription-based services, maintenance and support, and appraisal services to our clients. We can improve gross margins by controlling headcount and related costs and by expanding our revenue base, especially from those products and services that produce incremental revenue with minimal incremental cost, such as software licenses and royalties, subscription-based services, and maintenance and support. Our appraisal projects are cyclical in nature, and we often employ appraisal personnel on a short-term basis to coincide with the life of a project. As of
December 31, 2017
, our total employee count increased to
4,069
from
3,831
at
December 31, 2016
.
Selling, General and Administrative (“SG&A”) Expenses – The primary components of SG&A expenses are administrative and sales personnel salaries and commissions, share-based compensation expense, marketing expense, rent and professional fees. Sales commissions typically fluctuate with revenues and share-based compensation expense generally increases as the market price of our stock increases. Other administrative expenses tend to grow at a slower rate than revenues.
Liquidity and Cash Flows – The primary driver of our cash flows is net income. Uses of cash include acquisitions, capital investments in property and equipment and discretionary purchases of treasury stock. Our working capital needs are fairly stable throughout the year with the significant components of cash outflows being payment of personnel expenses offset by cash inflows representing collection of accounts receivable and cash receipts from clients in advance of revenue being earned. In recent years, we have also received significant amounts of cash from employees exercising stock options and contributing to our Employee Stock Purchase Plan.
Balance Sheet – Cash, accounts receivable and days sales outstanding and deferred revenue balances are important indicators of our business.
Recent Accounting Guidance not yet Adopted
Revenue from Contracts with Customers.
On May 28, 2014, the Financial Accounting Standards Board ("FASB") issued ASU No. 2014-09, “Revenue from Contracts with Customers.” This ASU is the result of a convergence project between the FASB and the International Accounting Standards Board. The core principle behind ASU No. 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for delivering those goods and services. This model involves a five-step process that includes identifying the contract with the customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction price to the performance obligations in the contract and recognizing revenue when (or as) the entity satisfies the performance obligations. The ASU allows two methods of adoption: a full retrospective approach where three years of financial information are presented in accordance with the new standard, and a modified retrospective approach where the ASU is applied to the most current period presented in the financial statements. We have adopted the new standard effective January 1, 2018 using the full retrospective method which will require each prior reporting period presented to be recast in future issuance of our financial statements. In preparation for adoption of the standard, we have implemented internal controls and key system functionality to enable the preparation of financial information and have reached conclusions on key accounting assessments related to the standard. During the fourth quarter of fiscal 2017, we have substantially completed data conversion activities required to recast our prior period results. We continue to perform an in-depth review of our preliminary results; therefore, we are in the process of completing our analysis necessary to recast prior period results. We do not believe there are any remaining significant implementation topics associated with the adoption of this ASU that have not yet been addressed.
This standard will have a material impact on our consolidated balance sheets and statement of shareholders’ equity. The impact of the standard on consolidated revenue and costs of revenue will be dependent upon the mix of revenue streams due to our accounting for software license fees, allocation of discounts across all performance obligations and to the incremental costs of obtaining a contract. Specifically, under the new standard software license fees under perpetual agreements will no longer be subject to 100% discount allocations from other elements in the contract. Discounts in arrangements will be allocated across all deliverables increasing license revenues and decreasing revenues allocated to other performance obligations. In addition, in most cases, net license fees (total license fees less any allocated discounts) will be recognized at the point in time that control of the software license transfers to the customer versus our current policy of recognizing revenue only to the extent billable per the contractual terms. Time-based license fees currently recognized over the license term will no longer be recognized over the period of the license and will instead be recognized at the point in time that control of the software license transfers to the customer. Revenue related to our software as a service (“SaaS”) offerings, post-contract customer support ("PCS") renewals and professional services remain substantially unchanged. Due to the complexity of certain contracts, the actual revenue recognition treatment required under the standard will be dependent on contract-specific terms and may vary in some instances from recognition at the time of billing.
Application of the new standard requires that incremental costs directly related to obtaining a contract (typically sales commissions plus any associated fringe benefits) must be recognized as an asset and expensed on a systematic basis that is consistent with the transfer to the customer of the goods and services to which the asset relates, unless that life is less than one year. Currently, we defer sales commissions and recognize expense over the relevant initial contractual term. With the adoption of the new standard, amortization periods will extend past the initial term.
Leases.
On February 25, 2016, the FASB issued its new lease accounting guidance in ASU No. 2016-02, “Leases (Topic 842).” Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date:
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•
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A lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and
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•
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A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.
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Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach.
The ASU is effective for fiscal years beginning after December 15, 2018, including interim periods therein. Early application is permitted for all business entities upon issuance. We are assessing the financial impact of adopting the new standard; however, we are currently unable to provide a reasonable estimate regarding the financial impact. We will adopt the new standard in fiscal year 2019.
Outlook
The local government software market continues to be active, and our backlog at
December 31, 2017
reached
$1.1 billion
, a
18%
increase from last year. We expect to continue to achieve solid growth in revenue and earnings. With our strong financial position and cash flow, we plan to continue to make significant investments in product development to better position us to continue to expand our competitive position in the public sector software market over the long term.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements, the reported amounts of revenues, cost of revenues and expenses during the reporting period, and related disclosure of contingencies. The Notes to the Financial Statements included as part of this Annual Report describe our significant accounting policies used in the preparation of the financial statements. Significant items subject to such estimates and assumptions include the application of the percentage-of-completion and proportional performance methods of revenue recognition, the carrying amount and estimated useful lives of intangible assets, determination of share-based compensation expense and valuation allowance for receivables. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies require significant judgments and estimates used in the preparation of our financial statements.
Revenue Recognition
. We recognize revenues in accordance with the provisions of Accounting Standards Codification (“ASC”) 605, Revenue Recognition and ASC 985-605, Software Revenue Recognition. Our revenues are derived from sales of software licenses and royalties, subscription-based services, appraisal services, maintenance and support, and services that typically range from installation, training and basic consulting to software modification and customization to meet specific customer needs. For multiple element software arrangements, which do not entail the performance of services that are considered essential to the functionality of the software, we generally record revenue when the delivered products or performed services result in a legally enforceable and non-refundable claim. We maintain allowances for doubtful accounts and sales adjustments, which are provided at the time the revenue is recognized. Because most of our customers are governmental entities, we rarely incur a loss resulting from the inability of a customer to make required payments. In a limited number of cases, we encounter a customer who is dissatisfied with some aspect of the software product or our service, and we may offer a “concession” to such customer. In those limited situations where we grant a concession, we rarely reduce the contract arrangement fee, but alternatively may perform additional services, such as additional training or creating additional custom reports. These amounts have historically been nominal. In connection with our customer contracts and the adequacy of related allowances and measures of progress towards contract completion, our project managers are charged with the responsibility to continually review the status of each customer on a specific contract basis. Also, we review, on at least a quarterly basis, significant past due accounts receivable and the adequacy of related reserves. Events or changes in circumstances that indicate that the carrying amount for the allowances for doubtful accounts and sales adjustments may require revision, include, but are not limited to, deterioration of a customer’s financial condition, failure to manage our customer’s expectations regarding the scope of the services to be delivered, and defects or errors in new versions or enhancements of our software products.
We use contract accounting, primarily the percentage-of-completion method, as discussed in ASC 605-35, Construction – Type and Certain Production – Type Contracts, for those software arrangements that involve significant production, modification or customization of the software, or where our software services are otherwise considered essential to the functionality of the software. We measure progress-to-completion primarily using labor hours incurred, or value added. In addition, we recognize revenue using the proportional performance method for our property appraisal projects, some of which can range up to five years. These methods rely on estimates of total expected contract revenue, billings and collections and expected contract costs, as well as measures of progress toward completion. We believe reasonably dependable estimates of revenue and costs and progress applicable to various stages of a contract can be made. At times, we perform additional and/or non-contractual services for little to no incremental fee to satisfy customer expectations. If changes occur in delivery, productivity or other factors used in developing our estimates of expected costs or revenues, we revise our cost and revenue estimates, and any revisions are charged to income in the period in which the facts that give rise to that revision first become known. In connection with these and certain other contracts, we may perform the work prior to when the services are billable and/or payable pursuant to the contract. The termination clauses in most of our contracts provide for the payment for the value of products delivered and services performed in the event of an early termination.
For SaaS arrangements, we evaluate whether the customer has the contractual right to take possession of our software at any time during the hosting period without significant penalty and whether the customer can feasibly maintain the software on the customer’s hardware or enter into another arrangement with a third-party to host the software. If we determine that the customer has the contractual right to take possession of our software at any time during the hosting period without significant penalty and can feasibly maintain the software on the customer’s hardware or enter into another arrangement with a third-party to host the software, we recognize the license, professional services and hosting services revenues pursuant to ASC 985-605, Software Revenue Recognition. For SaaS arrangements that do not meet the criteria for recognition under ASC 985-605, we account for the elements under ASC 605-25, Multiple Element Arrangements using all applicable facts and circumstances, including whether (i) the element has stand-alone value, (ii) there is a general right of return and (iii) the revenue is contingent on delivery of other elements. We allocate the contract value to each element of the arrangement that qualifies for treatment as a separate element based on vendor-specific objective evidence of fair value (“VSOE”), and if VSOE is not available, third-party evidence, and if third-party evidence is unavailable, estimated selling price. For professional services associated with SaaS arrangements that we determine do not have stand-alone value to the customer or are contingent on delivery of other elements, we recognize the services revenue ratably over the remaining contractual period once hosting has gone live and we may begin billing for the hosting services. We record amounts that have been invoiced in accounts receivable and in deferred revenue or revenues, depending on whether the revenue recognition criteria have been met.
In connection with certain of our contracts, we have recorded retentions receivable or unbilled receivables consisting of costs and estimated profit in excess of billings as of the balance sheet date. Many of the contracts which give rise to unbilled receivables at a given balance sheet date are subject to billings in the subsequent accounting period. We review unbilled receivables and related contract provisions to ensure we are justified in recognizing revenue prior to billing the customer and that we have objective evidence which allows us to recognize such revenue. In addition, we have a sizable amount of deferred revenue, which represents billings in excess of revenue earned. The majority of this liability consists of maintenance billings for which payments are made in advance and the revenue is ratably earned over the maintenance period, generally one year. We also have deferred revenue for those contracts in which we receive a deposit and the conditions in which to record revenue for the service or product have not been met. On a periodic basis, we review by customer the detail components of our deferred revenue to ensure our accounting remains appropriate.
Intangible Assets and Goodwill
. Our business acquisitions typically result in the creation of goodwill and other intangible asset balances, and these balances affect the amount and timing of future period amortization expense, as well as expense we could possibly incur as a result of an impairment charge. The cost of acquired companies is allocated to identifiable tangible and intangible assets based on estimated fair value, with the excess allocated to goodwill. Accordingly, we have a significant balance of acquisition date intangible assets, including software, customer related intangibles, trade name, leases and goodwill. These intangible assets (other than goodwill) are amortized over their estimated useful lives. We currently have no intangible assets with indefinite lives other than goodwill.
When testing goodwill for impairment quantitatively, we first compare the fair value of each reporting unit with its carrying amount. If the carrying amount of a reporting unit exceeds its fair value, a second step is performed to measure the amount of potential impairment. In the second step, we compare the implied fair value of reporting unit goodwill with the carrying amount of the reporting unit’s goodwill. If the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized. The fair values calculated in our impairment tests are determined using discounted cash flow models involving several assumptions. The assumptions that are used are based upon what we believe a hypothetical marketplace participant would use in estimating fair value. We base our fair value estimates on assumptions we believe to be reasonable but that are unpredictable and inherently uncertain. We evaluate the reasonableness of the fair value calculations of our reporting units by comparing the total of the fair value of all of our reporting units to our total market capitalization.
Our annual goodwill impairment analysis, which we performed quantitatively during the second quarter of
2017
, did not result in an impairment charge. During
2017
, we did not identify any triggering events that would require an update to our annual impairment review.
All intangible assets (other than goodwill) are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of other intangible assets is measured by comparison of the carrying amount to estimated undiscounted future cash flows. The assessment of recoverability or of the estimated useful life for amortization purposes will be affected if the timing or the amount of estimated future operating cash flows is not achieved. Such indicators may include, among others: a significant decline in expected future cash flows; a sustained, significant decline in stock price and market capitalization; a significant adverse change in legal factors or in the business climate; unanticipated competition; and reductions in growth rates. In addition, products, capabilities, or technologies developed by others may render our software products obsolete or non-competitive. Any adverse change in these factors could have a significant impact on the recoverability of goodwill or other intangible assets.
Share-Based Compensation.
We have a stock option plan that provides for the grant of stock options to key employees, directors and non-employee consultants. We estimate the fair value of share-based awards on the date of grant using the Black-Scholes option valuation model. Share-based compensation expense includes the estimated effects of forfeitures, which will be adjusted over the requisite service period to the extent actual forfeitures differ, or are expected to differ from such estimates. Changes in estimated forfeitures are recognized in the period of change and will also impact the amount of expense to be recognized in future periods. Forfeiture rate assumptions are derived from historical data.
We estimate stock price volatility at the date of grant based on the historical volatility of our common stock. Estimated option life is determined using the weighted-average period the stock options are expected to be outstanding based primarily on the options’ vesting terms, remaining contractual life and the employees’ expected exercise based on historical patterns. Determining the appropriate fair-value model and calculating the fair value of share-based awards at the grant date requires considerable judgment, including estimating stock price volatility, expected option life and forfeiture rates.
ANALYSIS OF RESULTS OF OPERATIONS AND OTHER
The following discussion compares the historical results of operations on a basis consistent with GAAP for the years ended
December 31, 2017
,
2016
and
2015
.
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Percentage of Total Revenues
Years Ended December 31,
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2017
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2016
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2015
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Revenues:
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Software licenses and royalties
|
9.0
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%
|
|
9.8
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%
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10.0
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%
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Subscriptions
|
20.6
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|
18.9
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|
18.9
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Software services
|
22.3
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23.1
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23.7
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Maintenance
|
43.0
|
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|
42.7
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|
41.6
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Appraisal services
|
3.0
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|
3.5
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4.2
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Hardware and other
|
2.1
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|
2.0
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1.6
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Total revenues
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100.0
|
|
|
100.0
|
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|
100.0
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Operating Expenses:
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Cost of software licenses, royalties and
acquired software
|
3.0
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|
3.3
|
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|
1.0
|
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|
Cost of software services, maintenance
and subscriptions
|
46.1
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46.2
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|
48.2
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Cost of appraisal services
|
1.9
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2.2
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2.7
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Cost of hardware and other
|
1.5
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1.3
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1.1
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Selling, general and administrative expenses
|
21.1
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|
22.1
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|
22.6
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Research and development expense
|
5.6
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|
5.7
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5.1
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Amortization of customer and trade name
intangibles
|
1.7
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1.8
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1.0
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|
Operating income
|
19.1
|
|
|
17.4
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|
18.3
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Other income (expense), net
|
0.1
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(0.3
|
)
|
|
0.1
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Income before income taxes
|
19.2
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|
17.1
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|
18.4
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|
Income tax (benefit) provision
|
(0.3
|
)
|
|
2.6
|
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|
7.4
|
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|
Net income
|
19.5
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%
|
|
14.5
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%
|
|
11.0
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%
|
2017
Compared to
2016
Revenues
Software licenses and royalties.
The following table sets forth a comparison of our software licenses and royalties revenue for the years ended December 31:
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Change
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($ in thousands)
|
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2017
|
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2016
|
|
$
|
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%
|
|
ES
|
|
$
|
67,840
|
|
|
$
|
68,844
|
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$
|
(1,004
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)
|
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(1
|
)%
|
|
A&T
|
|
7,854
|
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|
5,462
|
|
|
2,392
|
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|
44
|
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|
Total software licenses and royalties revenue
|
|
$
|
75,694
|
|
|
$
|
74,306
|
|
|
$
|
1,388
|
|
|
2
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%
|
Software license and royalties revenue was flat compared to the prior year. Software license revenue declined as a percentage of the revenue mix due to an increase in the percentage of new software clients choosing our subscription-based option, rather than purchasing the software under a traditional perpetual license arrangement.
Although the mix of new contracts between subscription-based and perpetual license arrangements may vary from quarter to quarter and year to year, we expect our longer-term software license growth rate to be negatively impacted by a growing number of customers choosing our subscription-based options, rather than purchasing the software under a traditional perpetual software license arrangement. Subscription-based arrangements result in lower software license revenue in the initial year as compared to perpetual software license arrangements but generate higher overall revenue over the term of the contract. Our new client mix in
2017
was approximately
53%
selecting perpetual software license arrangements and approximately
47%
selecting subscription-based arrangements compared to a client mix in
2016
of approximately
68%
selecting perpetual software license arrangements and approximately
32%
selecting subscription-based arrangements.
Subscriptions.
The following table sets forth a comparison of our subscriptions revenue for the years ended December 31:
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Change
|
|
($ in thousands)
|
|
2017
|
|
2016
|
|
$
|
|
%
|
|
ES
|
|
$
|
165,651
|
|
|
$
|
135,516
|
|
|
$
|
30,135
|
|
|
22
|
%
|
|
A&T
|
|
7,859
|
|
|
7,188
|
|
|
671
|
|
|
9
|
|
|
Total subscriptions revenue
|
|
$
|
173,510
|
|
|
$
|
142,704
|
|
|
$
|
30,806
|
|
|
22
|
%
|
Subscription-based revenue primarily consists of revenue derived from our SaaS arrangements, which utilize the Tyler private cloud. As part of our subscription-based services, we also provide electronic document filing solutions (“e-filing”) that simplify the filing and management of court related documents for courts and law offices. E-filing revenue is derived from transaction fees and fixed fee arrangements.
Subscription-based revenue increased
22%
compared to
2016
. New SaaS clients as well as existing clients who converted to our SaaS model provided the majority of the subscriptions revenue increase. In
2017
, we added
374
new SaaS clients and
88
existing clients elected to convert to our SaaS model. The average contract sizes in
2017
were
64%
and
44%
higher than
2016
for new clients and clients converting to our SaaS model, respectively. Also, e-filing services contributed approximately $
8.5 million
of the subscriptions revenue increase in
2017
. The increase in e-filing revenue is attributed to new e-filing clients, as well as increased volumes as the result of several existing clients mandating e-filing.
Software services.
The following table sets forth a comparison of our software services revenue for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2017
|
|
2016
|
|
$
|
|
%
|
|
ES
|
|
$
|
167,934
|
|
|
$
|
158,478
|
|
|
$
|
9,456
|
|
|
6
|
%
|
|
A&T
|
|
19,215
|
|
|
16,326
|
|
|
2,889
|
|
|
18
|
|
|
Total software services revenue
|
|
$
|
187,149
|
|
|
$
|
174,804
|
|
|
$
|
12,345
|
|
|
7
|
%
|
Software services revenue primarily consists of professional services billed in connection with implementing our software, converting client data, training client personnel, custom development activities and consulting. New clients who purchase our proprietary software licenses generally also contract with us to provide for the related software services. Existing clients also periodically purchase additional training, consulting and minor programming services. Software services revenue grew
7%
compared to the prior year period. This growth is partly due to additions to our implementation and support staff, which increased our capacity to deliver backlog and partially due to completing recognition of a majority of the acquisition-related deferred service revenue that was fair valued at rates below Tyler's average service rate in prior periods.
Maintenance.
The following table sets forth a comparison of our maintenance revenue for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2017
|
|
2016
|
|
$
|
|
%
|
|
ES
|
|
$
|
339,951
|
|
|
$
|
304,380
|
|
|
$
|
35,571
|
|
|
12
|
%
|
|
A&T
|
|
21,618
|
|
|
18,589
|
|
|
3,029
|
|
|
16
|
|
|
Total maintenance revenue
|
|
$
|
361,569
|
|
|
$
|
322,969
|
|
|
$
|
38,600
|
|
|
12
|
%
|
We provide maintenance and support services for our software products and certain third-party software. Maintenance revenue grew
12%
compared to the prior year. Maintenance and support revenue increased mainly due to growth in our installed customer base from new software license sales as well as annual maintenance rate increases. In addition, the increase is partially due to completing recognition of a majority of the acquisition-related deferred maintenance revenue that was fair valued at rates below Tyler's average maintenance rate in prior periods.
Appraisal services.
The following table sets forth a comparison of our appraisal services revenue for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2017
|
|
2016
|
|
$
|
|
%
|
|
ES
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
—
|
%
|
|
A&T
|
|
25,023
|
|
|
26,287
|
|
|
(1,264
|
)
|
|
(5
|
)
|
|
Total appraisal services revenue
|
|
$
|
25,023
|
|
|
$
|
26,287
|
|
|
$
|
(1,264
|
)
|
|
(5
|
)%
|
In
2017
, appraisal services revenue decreased
5%
compared to the prior year primarily due to the successful completion of several large revaluation projects in mid-2017. The appraisal services business is somewhat cyclical and driven in part by statutory revaluation cycles in various states.
Cost of Revenues and Gross Margins
The following table sets forth a comparison of the key components of our cost of revenues for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2017
|
|
2016
|
|
$
|
|
%
|
|
Software licenses and royalties
|
|
$
|
3,321
|
|
|
$
|
2,964
|
|
|
$
|
357
|
|
|
12
|
%
|
|
Acquired software
|
|
21,686
|
|
|
22,235
|
|
|
(549
|
)
|
|
(2
|
)
|
|
Software services, maintenance and subscriptions
|
|
387,634
|
|
|
348,939
|
|
|
38,695
|
|
|
11
|
|
|
Appraisal services
|
|
16,286
|
|
|
16,411
|
|
|
(125
|
)
|
|
(1
|
)
|
|
Hardware and other
|
|
12,595
|
|
|
10,143
|
|
|
2,452
|
|
|
24
|
|
|
Total cost of revenues
|
|
$
|
441,522
|
|
|
$
|
400,692
|
|
|
$
|
40,830
|
|
|
10
|
%
|
The following table sets forth a comparison of gross margin percentage by revenue type for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin percentage
|
|
2017
|
|
2016
|
|
Change
|
|
Software licenses, royalties and acquired software
|
|
67.0
|
%
|
|
66.1
|
%
|
|
0.9
|
%
|
|
Software services, maintenance and subscriptions
|
|
46.3
|
|
|
45.5
|
|
|
0.8
|
|
|
Appraisal services
|
|
34.9
|
|
|
37.6
|
|
|
(2.7
|
)
|
|
Hardware and other
|
|
28.9
|
|
|
32.3
|
|
|
(3.4
|
)
|
|
Overall gross margin
|
|
47.5
|
%
|
|
47.0
|
%
|
|
0.5
|
%
|
Software licenses, royalties and acquired software
. Cost of software licenses, royalties and acquired software is primarily comprised of amortization expense for acquired software and third-party software costs. We do not have any direct costs associated with royalties. The gross margin increase of
0.9%
is due to higher incremental margins on software license revenues, in part due to slightly lower amortization expense for acquired software resulting from acquisitions.
Software services, maintenance and subscriptions
. Cost of software services, maintenance and subscriptions primarily consists of personnel costs related to installation of our software, conversion of client data, training client personnel and support activities and various other services such as custom client development and on-going operation of SaaS and e-filing arrangements. In
2017
, the software services, maintenance and subscriptions gross margin increased
0.8%
compared to the prior year. Our implementation and support staff has grown by
220
employees since December 31,
2016
. Many of these additions occurred in early to mid-2017 and are contributing to revenue in 2017. Costs related to maintenance and various other services such as SaaS and e-filing typically grow at a slower rate than related revenue due to leverage in the utilization of support and maintenance staff and economies of scale. Reduced recognition of acquisition-related deferred revenue associated with software services and maintenance obligations completed in prior periods also resulted in higher gross margins.
Appraisal services
. Appraisal services revenue comprised approximately
3.0%
of total revenue. The appraisal services gross margin decreased
2.7%
compared to
2016
due to the reduction in higher margin projects substantially complete by early 2017 and lower volume of revenues in the current period to cover relatively fixed costs.
Our
2017
blended gross margin increased
0.5%
compared to
2016
. Our overall gross margin was positively impacted by a product mix that included more higher-margin recurring revenues from subscriptions and maintenance and improved margin on revenues from software licenses offset by the lower-margin revenues from appraisal services as described above.
Selling, General and Administrative Expenses
Selling, general and administrative (“SG&A”) expenses consist primarily of salaries, employee benefits, travel, share-based compensation expense, commissions and related overhead costs for administrative and sales and marketing employees, as well as, professional fees, trade show activities, advertising costs and other marketing related costs. The following table sets forth a comparison of our SG&A expenses for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2017
|
|
2016
|
|
$
|
|
%
|
|
Selling, general and administrative expenses
|
|
$
|
176,974
|
|
|
$
|
167,161
|
|
|
$
|
9,813
|
|
|
6
|
%
|
SG&A as a percentage of revenue was
21.1%
in
2017
compared to
22.1%
in
2016
. SG&A expense increased approximately
6%
mainly due to compensation costs related to increased staff levels, merit increases and higher stock compensation expense. We have added
28
employees mainly to our sales and finance teams since
December 31, 2016
. In addition, our
2017
stock compensation expense rose
$4.7 million
, mainly due to increases in our stock price over the last few years.
Research and Development Expense
Research and development expense consists primarily of salaries, employee benefits and related overhead costs associated with new product development. The following table sets forth a comparison of our research and development expense for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2017
|
|
2016
|
|
$
|
|
%
|
|
Research and development expense
|
|
$
|
47,324
|
|
|
$
|
43,154
|
|
|
$
|
4,170
|
|
|
10
|
%
|
Research and development expense consists mainly of costs associated with development of new products and technologies from which we do not currently generate revenue, as well as costs related to the ongoing development efforts for Microsoft Dynamics AX. Our contractual research and development commitment to develop public sector functionality for Microsoft Dynamics AX was amended in March 2016, which significantly reduced our development commitment through March 2018. However, we will continue to provide sustained engineering and technical support for the public sector functionality within Dynamics AX. License and maintenance royalties for all applicable domestic and international sales of Dynamics AX to public sector entities will continue under the terms of the contract.
Research and development expense increased
10%
in
2017
compared to the prior year period, mainly due to research and development efforts related to new Tyler product development initiatives, primarily in our public safety solutions, offset by reduced development efforts for Microsoft Dynamics AX. As a result of the Microsoft Dynamics AX amendment, we have redeployed certain development resources to enhance functionality on several existing solutions and these costs are being recorded in cost of revenues – software services, maintenance and subscriptions.
Amortization of Customer and Trade Name Intangibles
Acquisition intangibles are comprised of the excess of the purchase price over the fair value of net tangible assets acquired that is allocated to acquired software, leases and customer and trade name intangibles. The remaining excess purchase price is allocated to goodwill that is not subject to amortization. Amortization expense related to acquired software is included with cost of revenues, while amortization expense of customer and trade name intangibles is recorded as operating expense. The estimated useful lives of both customer and trade name intangibles range from five to 25 years. The following table sets forth a comparison of amortization of customer and trade name intangibles for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2017
|
|
2016
|
|
$
|
|
%
|
|
Amortization of customer and trade name intangibles
|
|
$
|
13,912
|
|
|
$
|
13,731
|
|
|
$
|
181
|
|
|
1
|
%
|
Amortization of customer and trade name intangibles increased due to the impact of intangibles added with several small acquisitions completed in
2016
and
2017
.
Estimated annual amortization expense relating to customer and trade name acquisition intangibles, excluding acquired software for which the amortization expense is recorded as cost of revenues, for the next five years is as follows (in thousands):
|
|
|
|
|
|
|
|
2018
|
$
|
13,819
|
|
|
2019
|
12,534
|
|
|
2020
|
11,402
|
|
|
2021
|
11,282
|
|
|
2022
|
10,792
|
|
Amortization expense relating to acquired leases will be recorded as a reduction to hardware and other revenue and is expected to be
$425,000
in
2018
,
$373,000
in
2019
,
$313,000
in
2020
,
$312,000
in
2021
,
$312,000
in
2022
and
$1.0 million
thereafter
.
Other
The following table sets forth a comparison of other income (expense), net for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2017
|
|
2016
|
|
$
|
|
%
|
|
Other income (expense), net
|
|
$
|
698
|
|
|
$
|
(1,998
|
)
|
|
$
|
2,696
|
|
|
N/M
|
Other income (expense) is comprised of interest expense and non-usage and other fees associated with our revolving credit agreement as well as interest income from invested cash. Other income (expense), net decrease compared to the prior period is attributed to significantly lower debt levels in the current period, as we repaid all borrowings under the revolving line of credit in January 2017, and correspondingly higher levels of cash investments.
Income Tax (Benefit) Provision
The following table sets forth a comparison of our income tax provision for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2017
|
|
2016
|
|
$
|
|
%
|
|
Income tax (benefit) provision
|
|
$
|
(2,317
|
)
|
|
$
|
19,450
|
|
|
$
|
(21,767
|
)
|
|
(112
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
Effective income tax rate
|
|
(1.4
|
)%
|
|
15.0
|
%
|
|
|
|
|
The decrease in the income tax provision during 2017 was primarily driven by the enactment of the Tax Act which reduced the statutory U.S. federal corporate income tax rate from 35% to 21%. The impact of the rate reduction on our 2017 income tax provision is a
$21.6 million
tax benefit due to the remeasurement of deferred tax assets and liabilities.
See Note 7 - "Income Tax" for additional information related to the Tax Act. The income tax provision is also lower due to the increase in the excess tax benefits from stock option exercises as compared to prior period. We experienced significant stock option exercise activity in
2017
and
2016
that generated excess tax benefits of
$40.6 million
and
$29.6 million
, respectively.
The change in the effective income tax rate in
2017
compared to
2016
is also primarily attributable to the impact of the Tax Act and the changes in excess tax benefits related to stock option exercises realized. Excluding the impact of the Tax Act and the excess tax benefits, our income tax provision and effective tax rate in
2017
would have been
$59.9 million
and
37.1%
, respectively. Excluding the excess tax benefits, our income tax provision and effective tax rate in 2016 would have been $49.0 million and 37.9%, respectively.
The effective income tax rates in both
2017
and
2016
differed from the statutory United States federal corporate income tax rate of 35% due to state income taxes, the domestic production activities deduction, the research tax credit, non-deductible share-based compensation expense, disqualifying incentive stock option dispositions, and non-deductible business expenses.
2016
Compared to
2015
Revenues
On November 16, 2015, we acquired NWS, which provides public safety and financial solutions for local governments. In May 2015, we acquired a company which provides mobile hand-held solutions primarily to law enforcement agencies for field accident reporting and electronically issuing citations. The results of their operations are included in our ES segment from their respective dates of acquisition. For comparative purposes, we have provided explanations for changes in operations to exclude results of operations for these acquisitions noting the exclusion.
Software licenses and royalties.
The following table sets forth a comparison of our software licenses and royalties revenue for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2016
|
|
2015
|
|
$
|
|
%
|
|
ES
|
|
$
|
68,844
|
|
|
$
|
54,376
|
|
|
$
|
14,468
|
|
|
27
|
%
|
|
A&T
|
|
5,462
|
|
|
4,632
|
|
|
830
|
|
|
18
|
|
|
Total software licenses and royalties revenue
|
|
$
|
74,306
|
|
|
$
|
59,008
|
|
|
$
|
15,298
|
|
|
26
|
%
|
Excluding the results of acquisitions, software license revenue increased 3% compared to the prior year. The majority of this growth was due to a more active marketplace as the result of improvement in local government economic conditions, as well as our increasingly strong competitive position, which we attribute in part to our investment in product development in recent years. This increase was offset somewhat by lower sales to our existing customer base for courts and justice related add-on solutions that assist and support the transition to a paperless environment. By the end of 2015, the majority of our courts and justice clients had implemented these add-on solutions.
Although the mix of new contracts between subscription-based and perpetual license arrangements may vary from quarter to quarter and year to year, our longer-term software license growth rate is negatively impacted by a growing number of customers choosing our subscription-based options, rather than purchasing the software under a traditional perpetual software license arrangement. Subscription-based arrangements result in lower software license revenue in the initial year as compared to perpetual software license arrangements but generate higher overall revenue over the term of the contract. Our new client mix in 2016 was approximately 68% selecting perpetual software license arrangements and approximately 32% selecting subscription-based arrangements compared to a client mix in 2015 of approximately 76% selecting perpetual software license arrangements and approximately 24% selecting subscription-based arrangements. 250 new clients entered into subscription-based software arrangements in 2016 compared to 134 new clients in 2015.
Subscriptions.
The following table sets forth a comparison of our subscriptions revenue for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2016
|
|
2015
|
|
$
|
|
%
|
|
ES
|
|
$
|
135,516
|
|
|
$
|
107,090
|
|
|
$
|
28,426
|
|
|
27
|
%
|
|
A&T
|
|
7,188
|
|
|
4,843
|
|
|
2,345
|
|
|
48
|
|
|
Total subscriptions revenue
|
|
$
|
142,704
|
|
|
$
|
111,933
|
|
|
$
|
30,771
|
|
|
27
|
%
|
Subscription-based revenue primarily consists of revenue derived from our SaaS arrangements, which utilize the Tyler private cloud. As part of our subscription-based services, we also provide electronic document filing solutions (“e-filing”) that simplify the filing and management of court related documents for courts and law offices. E-filing revenue is derived from transaction fees and fixed fee arrangements.
Excluding acquisitions, subscription-based revenue increased 24% compared to 2015. E-filing services contributed approximately $4.9 million of the subscriptions revenue increase in 2016. Most of the e-filing revenue increase related to several statewide contracts, several of which implemented mandatory electronic filing during 2015 and throughout 2016. New SaaS clients as well as existing clients who converted to our SaaS model provided the remainder of the subscriptions revenue increase. In 2016, we added 250 new SaaS clients and 53 existing clients elected to convert to our SaaS model. The average contract sizes in 2016 were 1% and 9% higher than 2015 for new clients and clients converting to our SaaS model, respectively.
Software services.
The following table sets forth a comparison of our software services revenue for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2016
|
|
2015
|
|
$
|
|
%
|
|
ES
|
|
$
|
158,478
|
|
|
$
|
129,068
|
|
|
$
|
29,410
|
|
|
23
|
%
|
|
A&T
|
|
16,326
|
|
|
10,784
|
|
|
5,542
|
|
|
51
|
|
|
Total software services revenue
|
|
$
|
174,804
|
|
|
$
|
139,852
|
|
|
$
|
34,952
|
|
|
25
|
%
|
Software services revenue primarily consists of professional services billed in connection with implementing our software, converting client data, training client personnel, custom development activities and consulting. New clients who purchase our proprietary software licenses generally also contract with us to provide for the related software services. Existing clients also periodically purchase additional training, consulting and minor programming services. Excluding the results of acquisitions, software services revenue grew 11% compared to the prior year period. This growth is partly due to additions to our implementation and support staff, which increased our capacity to deliver backlog, and a contract mix that included more custom development and other services.
Maintenance.
The following table sets forth a comparison of our maintenance revenue for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2016
|
|
2015
|
|
$
|
|
%
|
|
ES
|
|
$
|
304,380
|
|
|
$
|
227,586
|
|
|
$
|
76,794
|
|
|
34
|
%
|
|
A&T
|
|
18,589
|
|
|
17,951
|
|
|
638
|
|
|
4
|
|
|
Total maintenance revenue
|
|
$
|
322,969
|
|
|
$
|
245,537
|
|
|
$
|
77,432
|
|
|
32
|
%
|
We provide maintenance and support services for our software products and certain third-party software. Excluding the results of acquisitions, maintenance revenue grew 9% compared to the prior year. Maintenance and support revenue increased mainly due to growth in our installed customer base from new software license sales as well as annual maintenance rate increases.
Appraisal services.
The following table sets forth a comparison of our appraisal services revenue for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2016
|
|
2015
|
|
$
|
|
%
|
|
ES
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
—
|
%
|
|
A&T
|
|
26,287
|
|
|
25,065
|
|
|
1,222
|
|
|
5
|
|
|
Total appraisal services revenue
|
|
$
|
26,287
|
|
|
$
|
25,065
|
|
|
$
|
1,222
|
|
|
5
|
%
|
The appraisal services business is somewhat cyclical and driven in part by statutory revaluation cycles in various states. In 2016, appraisal services revenue increased 5% compared to prior year primarily due to the Franklin County, Ohio, revaluation project, which began late in the fourth quarter of 2015.
Cost of Revenues and Gross Margins
The following table sets forth a comparison of the key components of our cost of revenues for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2016
|
|
2015
|
|
$
|
|
%
|
|
Software licenses and royalties
|
|
$
|
2,964
|
|
|
$
|
1,632
|
|
|
$
|
1,332
|
|
|
82
|
%
|
|
Acquired software
|
|
22,235
|
|
|
4,440
|
|
|
17,795
|
|
|
N/M
|
|
|
Software services, maintenance and subscriptions
|
|
348,939
|
|
|
285,340
|
|
|
63,599
|
|
|
22
|
|
|
Appraisal services
|
|
16,411
|
|
|
15,922
|
|
|
489
|
|
|
3
|
|
|
Hardware and other
|
|
10,143
|
|
|
6,501
|
|
|
3,642
|
|
|
56
|
|
|
Total cost of revenues
|
|
$
|
400,692
|
|
|
$
|
313,835
|
|
|
$
|
86,857
|
|
|
28
|
%
|
The following table sets forth a comparison of gross margin percentage by revenue type for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin percentage
|
|
2016
|
|
2015
|
|
Change
|
|
Software licenses, royalties and acquired software
|
|
66.1
|
%
|
|
89.7
|
%
|
|
(23.6
|
)%
|
|
Software services, maintenance and subscriptions
|
|
45.5
|
|
|
42.6
|
|
|
2.9
|
|
|
Appraisal services
|
|
37.6
|
|
|
36.5
|
|
|
1.1
|
|
|
Hardware and other
|
|
32.3
|
|
|
32.5
|
|
|
(0.2
|
)
|
|
Overall gross margin
|
|
47.0
|
%
|
|
46.9
|
%
|
|
0.1
|
%
|
Software licenses, royalties and acquired software
. Cost of software licenses, royalties and acquired software is primarily comprised of amortization expense for acquired software and third-party software costs. We do not have any direct costs associated with royalties. In 2016, our software licenses, royalties and acquired software gross margin percentage declined compared to the prior year due to much higher amortization expense for acquired software resulting from our acquisition of NWS. Excluding the results of NWS, our software license, royalties and acquired software gross margin was 93.9% in 2016 compared to 93.6% in 2015.
Software services, maintenance and subscriptions
. Cost of software services, maintenance and subscriptions primarily consists of personnel costs related to installation of our software, conversion of client data, training client personnel and support activities and various other services such as custom client development and on-going operation of SaaS and e-filing arrangements. In 2016, the software services, maintenance and subscriptions gross margin increased 2.9% compared to the prior year. Our implementation and support staff grew by 169 employees in 2016. To support sales growth, we began making significant investments in our implementation and support staff in early 2015. Since December 31, 2014, excluding acquisitions, we added 369 implementation and support employees. These additions contributed to the revenue growth in 2016. In addition, the NWS revenue mix included a lower proportion of software services compared to Tyler’s historical revenue mix, which also benefited the gross margin. Costs related to maintenance and various other services such as SaaS and e-filing typically grow at a slower rate than related revenue due to leverage in the utilization of support and maintenance staff and economies of scale. Maintenance and subscription price increases also resulted in slightly higher gross margins.
Appraisal services
. Appraisal services revenue comprised approximately 3.5% of total revenue. The appraisal services gross margin increased 1.1% compared to 2015. A high proportion of the costs of appraisal services revenue are variable, as we often hire temporary employees to assist in appraisal projects, whose term of employment generally ends with the projects’ completion.
Our 2016 blended gross margin remained consistent compared to 2015. Our overall gross margin was positively impacted by improved utilization of our support and maintenance staff; however, this benefit was offset by amortization expense for acquired software related to the NWS acquisition.
Selling, General and Administrative Expenses
The following table sets forth a comparison of selling, general and administrative expenses for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2016
|
|
2015
|
|
$
|
|
%
|
|
Selling, general and administrative expenses
|
|
$
|
167,161
|
|
|
$
|
133,317
|
|
|
$
|
33,844
|
|
|
25
|
%
|
SG&A as a percentage of revenue was 22.1% in 2016 compared to 22.6% in 2015. In 2015, our SG&A expense included approximately $5.9 million for financial advisory, legal, accounting, due diligence, valuation and other various expenses necessary to complete the NWS acquisition. Excluding NWS transaction costs and SG&A from acquisitions, SG&A expense increased approximately 12% mainly due to compensation costs related to increased staff levels, higher stock compensation expense and increased commission expense as a result of higher sales. We added 22 employees mainly to our sales and finance teams in 2016. In addition, our 2016 stock compensation expense rose $6.4 million, mainly due to increases in our stock price over the last few years.
Research and Development Expense
The following table sets forth a comparison of our research and development expense for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2016
|
|
2015
|
|
$
|
|
%
|
|
Research and development expense
|
|
$
|
43,154
|
|
|
$
|
29,922
|
|
|
$
|
13,232
|
|
|
44
|
%
|
Research and development expense consists mainly of costs associated with development of new products and technologies from which we do not currently generate revenue, as well as costs related to the ongoing development efforts for Microsoft Dynamics AX. Our contractual research and development commitment to develop public sector functionality for Microsoft Dynamics AX was amended in March 2016, which significantly reduced our development commitment through March 2018. However, we will continue to provide sustained engineering and technical support for the public sector functionality within Dynamics AX. License and maintenance royalties for all applicable domestic and international sales of Dynamics AX to public sector entities will continue under the terms of the contract.
Excluding the results of acquisitions, research and development expense increased 1.5% in 2016 compared to the prior year period, mainly due to research and development efforts related to new Tyler product development initiatives. As a result of the Microsoft Dynamics AX amendment, we also redeployed certain development resources to enhance functionality on several existing solutions and these costs were recorded in cost of sales – software services, maintenance and subscriptions.
Amortization of Customer and Trade Name Intangibles
The following table sets forth a comparison of amortization of customer and trade name intangibles for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2016
|
|
2015
|
|
$
|
|
%
|
|
Amortization of customer and trade name intangibles
|
|
$
|
13,731
|
|
|
$
|
5,905
|
|
|
$
|
7,826
|
|
|
133
|
%
|
Amortization of customer and trade name intangibles increased substantially from the comparable prior year periods due to the acquisition of NWS in November 2015.
Other
The following table sets forth a comparison of other (expense) income, net for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2016
|
|
2015
|
|
$
|
|
%
|
|
Other (expense) income, net
|
|
$
|
(1,998
|
)
|
|
$
|
381
|
|
|
$
|
(2,379
|
)
|
|
N/M
|
Other (expense) income is comprised of interest expense and non-usage and other fees associated with our revolving credit agreement as well as interest income from invested cash. In 2015, we had significantly higher invested cash balances and no outstanding debt until we completed the NWS acquisition on November 16, 2015.
Income Tax Provision
The following table sets forth a comparison of our income tax provision for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
($ in thousands)
|
|
2016
|
|
2015
|
|
$
|
|
%
|
|
Income tax provision
|
|
$
|
19,450
|
|
|
$
|
43,555
|
|
|
$
|
(24,105
|
)
|
|
(55
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
Effective income tax rate
|
|
15.0
|
%
|
|
40.2
|
%
|
|
|
|
|
The decrease in the income tax provision during 2016 was primarily driven by the adoption of ASU No. 2016-09, which requires the excess tax benefits from stock option exercises to be recognized as a reduction of the income tax provision, whereas they previously were accounted for as an increase to shareholders’ equity. The adoption of ASU No. 2016-09 resulted in a $29.6 million decrease in our full year 2016 provision for income taxes.
Excluding the excess tax benefits, our income tax provision and effective tax rate in 2016 would have been $49.0 million and 37.9%, respectively.
The effective income tax rates in both 2016 and 2015 also differed from the statutory United States federal income tax rate of 35% due to state income taxes, the domestic production activities deduction, non-deductible share-based compensation expense, disqualifying incentive stock option dispositions, and non-deductible business expenses. We realized a lower domestic production activities deduction as a result of taxable income limitations and non-deductible transaction costs related to the NWS acquisition negatively impacted our 2015 effective tax rate. In the past few years a relatively high amount of excess tax benefits related to stock option exercises have resulted in a reduction in our qualified manufacturing activities deduction. The qualified manufacturing activities deduction can be limited to a certain level of taxable income on the tax return. Therefore, any significant items that reduce taxable income, such as excess tax benefits on stock options, can reduce the amount of the qualified manufacturing activities deduction. We experienced significant stock option exercise activity in 2016 and 2015 that generated excess tax benefits of $29.6 million and $45.3 million, respectively.
FINANCIAL CONDITION AND LIQUIDITY
As of
December 31, 2017
, we had cash and cash equivalents of
$185.9 million
compared to
$36.2 million
at
December 31, 2016
. We also had
$63.8 million
invested in investment grade corporate bonds, municipal bonds and asset-backed securities as of
December 31, 2017
. These investments mature between
2017 through 2021
and we intend to hold these investments until maturity. Cash and cash equivalents consist of cash on deposit with several domestic banks and money market funds. As of
December 31, 2017
, we had
no
outstanding borrowings and one outstanding letter of credit totaling
$0.5 million
in favor of a client contract. The letter of credit guarantees our performance under the contract and expires in
2018
. We believe our revolving line of credit, cash from operating activities, cash on hand and access to the credit markets provide us with sufficient flexibility to meet our long-term financial needs.
The following table sets forth a summary of cash flows for the years ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in thousands)
|
|
2017
|
|
2016
|
|
2015
|
|
Cash flows provided (used) by:
|
|
|
|
|
|
|
|
Operating activities
|
|
$
|
195,755
|
|
|
$
|
191,859
|
|
|
$
|
134,327
|
|
|
Investing activities
|
|
(85,395
|
)
|
|
(50,720
|
)
|
|
(398,459
|
)
|
|
Financing activities
|
|
39,415
|
|
|
(138,075
|
)
|
|
91,052
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
$
|
149,775
|
|
|
$
|
3,064
|
|
|
$
|
(173,080
|
)
|
Net cash provided by operating activities continues to be our primary source of funds to finance operating needs and capital expenditures. Other potential capital resources include cash on hand, public and private issuances of debt or equity securities, and bank borrowings. It is possible that our ability to access the capital and credit markets in the future may be limited by economic conditions or other factors. We currently believe that cash provided by operating activities, cash on hand and available credit are sufficient to fund our working capital requirements, capital expenditures, income tax obligations, and share repurchases for at least the next twelve months.
In
2017
, operating activities provided cash of
$195.8 million
compared to
$191.9 million
in
2016
. Operating activities that provided cash were primarily comprised of net income of
$163.9 million
, non-cash depreciation and amortization charges of
$53.9 million
and non-cash share-based compensation expense of
$37.3 million
. Working capital, excluding cash, increased approximately
$63.6 million
million mainly due to higher accounts receivable related to annual maintenance and subscription billings as well as milestone billings for several contracts, timing of income tax payments, and the deferred taxes associated with stock option activity during the period. These increases were offset slightly by the growth in deferred revenue balances and timing of payments of payroll related taxes and vendor invoices.
In general, changes in the balance of deferred revenue are cyclical and primarily driven by the timing of our maintenance renewal billings. Our renewal dates occur throughout the year but our largest renewal cycles occur in the second and fourth quarters.
Days sales outstanding in accounts receivable were
94
days at
December 31, 2017
, compared to
93
days at
December 31, 2016
. DSO is calculated based on quarter-end accounts receivable (excluding long-term receivables, but including unbilled receivables) divided by the quotient of annualized quarterly revenues divided by 360 days.
Investing activities used cash of
$85.4 million
in
2017
compared to
$50.7 million
in
2016
. We invested
$59.8 million
and received
$28.8 million
in proceeds from investment grade corporate bonds, municipal bonds and asset-backed securities with maturity dates ranging from
2017 through 2021
. Approximately
$43.1 million
was invested in property and equipment. We purchased an office building in Latham, New York for approximately
$2.9 million
and paid
$2.1 million
for building improvements. We paid
$19.4 million
for construction to expand our office building in Yarmouth, Maine. We also made three small acquisitions with a combined cash purchase price of
$11.3 million
. The remaining additions were for computer equipment, furniture and fixtures in support of internal growth, particularly with respect to our cloud-based offerings. These expenditures were funded from cash generated from operations.
In 2016, we made a small acquisition for approximately $7.4 million and paid $2.0 million related to the working capital holdback in connection with the NWS acquisition. We invested $20.3 million in investment grade corporate and municipal bonds. We purchased an office building in Falmouth, Maine, that was previously leased from an entity owned by an executive’s father and brother, for approximately $9.7 million and paid $8.0 million for construction to expand our office building in Yarmouth, Maine. The remaining use of cash was for capital expenditures related to computer equipment, furniture and fixtures in support of internal growth, particularly with respect to growth in our cloud-based offerings. These expenditures were funded from cash generated from operations.
In 2015, we completed the acquisition of NWS for the purchase price of $337.5 million in cash, of which $4.0 million was accrued at December 31, 2015, and 2.1 million shares of Tyler common stock valued at $362.8 million. Also, we completed a small acquisition with a purchase price of $6.1 million in cash and 12,500 shares of Tyler common stock valued at $1.5 million and we made a $15.0 million investment in convertible preferred stock representing a 20% interest in Record Holdings Pty Limited. We also invested $30.9 million in investment grade corporate and municipal bonds. The remaining use of cash was for capital expenditures related to computer equipment, furniture and fixtures in support of internal growth, particularly with respect to growth in our cloud-based offerings. These expenditures were funded from cash generated from operations, cash on hand and bank borrowings.
Financing activities provided cash of
$39.4 million
in
2017
compared to cash used of
$138.1 million
in
2016
. Financing activities in
2017
were comprised of
$10.0 million
net payments on our revolving line of credit offset by collections of
$56.9 million
from stock option exercises and employee stock purchase plan activity. We also purchased approximately
44,000
shares of our common stock for an aggregate purchase price of
$6.6 million
.
Financing activities in 2016 were comprised of $56.0 million net payments on our revolving line of credit offset somewhat by collections of $29.8 million from stock option exercises and employee stock purchase plan activity. We also purchased approximately 882,000 shares of our common stock for an aggregate purchase price of $112.7 million, of which $860,000 was accrued at December 31, 2016. Cash provided by financing activities in 2015 resulted from net borrowings of $66.0 million and collections of $27.8 million from stock option exercises and employee stock purchase plan activity. We also purchased approximately 5,400 shares of our common stock for an aggregate purchase price of $645,000 in 2015 and paid $2.1 million in debt issuance costs.
On May 11, 2016, our board of directors authorized the repurchase of an additional 1.5 million shares of Tyler common stock. The repurchase program, which was approved by our board of directors, was announced in October 2002, and was amended at various times from 2003 through 2016. As of
December 31, 2017
, we had remaining authorization to repurchase up to
2.0 million
additional shares of our common stock. Our share repurchase program allows us to repurchase shares at our discretion. Market conditions influence the timing of the buybacks and the number of shares repurchased, as well as the volume of employee stock option exercises. Share repurchases are generally funded using our existing cash balances and borrowings under our credit facility and may occur through open market purchases and transactions structured through investment banking institutions, privately negotiated transactions and/or other mechanisms. There is no expiration date specified for the authorization and we intend to repurchase stock under the plan from time to time.
On
November 16, 2015
, we entered into a
$300.0 million
Credit Agreement (the “Credit Facility”) with the various lenders party thereto and Wells Fargo Bank, National Association, as Administrative Agent. The Credit Facility provides for a revolving credit line of up to $
300.0 million
, including a
$10.0 million
sublimit for letters of credit. The Credit Facility matures on
November 16, 2020
. Borrowings under the Credit Facility may be used for general corporate purposes, including working capital requirements, acquisitions and share repurchases. Borrowings under the Credit Facility bear interest at a rate of either (1) Wells Fargo Bank’s prime rate (subject to certain higher rate determinations) plus a margin of
0.25%
to
1.00%
or (2) the 30, 60, 90 or 180 day LIBOR rate plus a margin of
1.25%
to
2.00%
. As of
December 31, 2017
, our interest rate was
4.75%
under the prime rate option or approximately
2.78%
under the 30-day LIBOR option. The Credit Facility is secured by substantially all of our assets. The Credit Facility requires us to maintain certain financial ratios and other financial conditions and prohibits us from making certain investments, advances, cash dividends or loans, and limits incurrence of additional indebtedness and liens. As of
December 31, 2017
, we were in compliance with those covenants
.
As of
December 31, 2017
, we had
no
outstanding borrowings and had unused borrowing capacity of
$299.5 million
under the Credit Facility
.
We paid interest of
$804,000
in
2017
,
$1.9 million
in
2016
, and
$223,000
in
2015
.
We paid income taxes, net of refunds received, of
$36.0 million
in
2017
,
$30.2 million
in
2016
, and
$27.3 million
in
2015
. In 2017, we experienced significant stock option exercise activity that generated net tax benefits of
$40.6 million
and reduced tax payments accordingly. In 2016 and 2015, excess tax benefits were $29.6 million and $45.3 million, respectively.
The Tax Act, enacted on December 22, 2017, reduced the U.S. federal corporate income tax rate from 35% to 21% effective January 1, 2018. We expect that the Tax Act will have a positive impact on liquidity in future years due to the decrease in the U.S. corporate income tax rate.
We anticipate that 2018 capital spending will be between $22 million and $25 million, including approximately $1 million related to real estate. We expect the majority of the other capital spending will consist of computer equipment and software for infrastructure replacements and expansion. We currently do not expect to capitalize significant amounts related to software development in 2018, but the actual amount and timing of those costs, and whether they are capitalized or expensed may result in additional capitalized software development. Capital spending is expected to be funded from existing cash balances, cash flows from operations and borrowings under our revolving line of credit.
From time to time we engage in discussions with potential acquisition candidates. In order to pursue such opportunities, which could require significant commitments of capital, we may be required to incur debt or to issue additional potentially dilutive securities in the future. No assurance can be given as to our future acquisition opportunities and how such opportunities will be financed.
We lease office facilities, as well as transportation, computer and other equipment used in our operations under non-cancelable operating lease agreements expiring at various dates through
2025
. Most leases contain renewal options and some contain purchase options.
Summarized in the table below are our obligations to make future payments under our Credit Facility and lease obligations at
December 31, 2017
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2018
|
|
2019
|
|
2020
|
|
2021
|
|
2022
|
|
Thereafter
|
|
Total
|
|
Revolving line of credit
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
Lease obligations
|
5,428
|
|
|
4,201
|
|
|
3,644
|
|
|
2,366
|
|
|
812
|
|
|
499
|
|
|
16,950
|
|
|
Total future payment obligations
|
$
|
5,428
|
|
|
$
|
4,201
|
|
|
$
|
3,644
|
|
|
$
|
2,366
|
|
|
$
|
812
|
|
|
$
|
499
|
|
|
$
|
16,950
|
|
As of
December 31, 2017
, we do not have any off-balance sheet arrangements, guarantees to third-parties or material purchase commitments, except for the operating lease commitments listed above.
CAPITALIZATION
At
December 31, 2017
, our capitalization consisted of
no
outstanding borrowings and
$1.2 billion
of shareholders’ equity.