10-Q 1 tyl930201810q-document.htm 10-Q Document


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
 
x
 
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 2018
OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
Commission File Number 1-10485
TYLER TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)

DELAWARE
 
75-2303920
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. employer
identification no.)
5101 TENNYSON PARKWAY
PLANO, TEXAS
75024
(Address of principal executive offices)
(Zip code)
(972) 713-3700
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes   x  No  
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes   x     No  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definition of “large accelerated filer," "accelerated filer,” "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
 
x
  
Accelerated filer
 
 
 
 
 
Non-accelerated filer
 
  
Smaller reporting company
 
 
 
 
 
Emerging growth company
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes       No   x
The number of shares of common stock of registrant outstanding on October 30, 2018 was 38,823,257.
 




PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements
TYLER TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
 
 
As Adjusted
 
 
 
As Adjusted
Revenues:
 
 
 
 
 
 
 
 
Software licenses and royalties
 
$
22,444

 
$
22,762

 
$
67,620

 
$
63,826

Subscriptions
 
58,699

 
44,352

 
160,736

 
124,731

Software services
 
48,199

 
46,045

 
144,812

 
134,401

Maintenance
 
96,215

 
91,847

 
286,188

 
266,965

Appraisal services
 
5,544

 
6,290

 
16,470

 
19,268

Hardware and other
 
4,966

 
3,410

 
17,475

 
14,007

Total revenues
 
236,067

 
214,706


693,301


623,198

 
 
 
 
 
 
 
 
 
Cost of revenues:
 
 
 
 
 
 
 
 
Software licenses and royalties
 
957

 
826

 
2,939

 
2,204

Acquired software
 
5,897

 
5,473

 
17,003

 
16,243

Software services, maintenance and subscriptions
 
111,508

 
98,036

 
327,080

 
287,748

Appraisal services
 
3,505

 
4,089

 
10,854

 
12,568

Hardware and other
 
2,574

 
2,293

 
11,718

 
10,408

Total cost of revenues
 
124,441

 
110,717

 
369,594

 
329,171

 
 
 
 
 
 
 
 
 
Gross profit
 
111,626

 
103,989

 
323,707

 
294,027

 
 
 
 
 
 
 
 
 
Selling, general and administrative expenses
 
52,605

 
44,513

 
152,471

 
130,293

Research and development expense
 
17,050

 
11,834

 
45,929

 
35,307

Amortization of customer and trade name intangibles
 
4,386

 
3,360

 
11,742

 
10,016

 
 
 
 
 
 
 
 
 
Operating income
 
37,585

 
44,282

 
113,565

 
118,411

 
 
 
 
 
 
 
 
 
Other income (expense), net
 
1,041

 
75

 
2,198

 
(216
)
Income before income taxes
 
38,626

 
44,357

 
115,763

 
118,195

Income tax (benefit) provision
 
(298
)
 
5,521

 
(147
)
 
14,820

Net income
 
$
38,924

 
$
38,836

 
$
115,910

 
$
103,375

 
 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
 
Basic
 
$
1.00

 
$
1.04

 
$
3.01

 
$
2.78

Diluted
 
$
0.96

 
$
0.99

 
$
2.87

 
$
2.63

See accompanying notes.

2



TYLER TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value and share amounts)
 
 
September 30, 2018
(unaudited)
 
December 31, 2017
 
 
 
 
As Adjusted
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
219,452

 
$
185,926

Accounts receivable [less allowance for doubtful accounts of $5,110 in 2018 and $5,427 in 2017]
 
281,523

 
246,188

Short-term investments
 
52,349

 
43,159

Prepaid expenses
 
32,790

 
32,206

Income tax receivable
 
13,281

 
11,339

Other current assets
 
2,299

 
1,997

Total current assets
 
601,694

 
520,815

 
 
 
 
 
Accounts receivable, long-term
 
12,966

 
12,107

Property and equipment, net
 
156,498

 
152,315

Other assets:
 
 
 
 
Goodwill
 
749,502

 
657,987

Other intangibles, net
 
282,806

 
229,617

Non-current investments and other assets
 
61,156

 
38,510

 Total assets
 
$
1,864,622

 
$
1,611,351

 
 
 
 
 
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
4,597

 
$
8,174

Accrued liabilities
 
66,020

 
64,675

Deferred revenue
 
326,421

 
298,613

Total current liabilities
 
397,038

 
371,462

 
 
 
 
 
Deferred revenue, long-term
 
493

 
1,274

Deferred income taxes
 
44,965

 
46,879

 
 
 
 
 
Commitments and contingencies
 

 

 
 
 
 
 
Shareholders' equity:
 
 
 
 
Preferred stock, $10.00 par value; 1,000,000 shares authorized; none issued
 

 

Common stock, $0.01 par value; 100,000,000 shares authorized; 48,147,969 shares
   issued and outstanding as of September 30, 2018 and December 31, 2017
 
481

 
481

Additional paid-in capital
 
724,935

 
626,867

Accumulated other comprehensive loss, net of tax
 
(46
)
 
(46
)
Retained earnings
 
740,373

 
624,463

Treasury stock, at cost; 9,179,922 and 10,262,182 shares in 2018 and 2017, respectively
 
(43,617
)
 
(60,029
)
Total shareholders' equity
 
1,422,126

 
1,191,736

 Total liabilities and shareholders' equity
 
$
1,864,622

 
$
1,611,351

See accompanying notes.

3



TYLER TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
 
 
 
As Adjusted
Cash flows from operating activities:
 
 
 
 
Net income
 
$
115,910

 
$
103,375

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
45,627

 
39,700

Share-based compensation expense
 
37,966

 
27,368

Deferred income tax benefit
 
(5,034
)
 
(13,705
)
Changes in operating assets and liabilities, exclusive of effects of
   acquired companies:
 
 
 
 
Accounts receivable
 
(31,393
)
 
(6,672
)
Income taxes
 
(1,942
)
 
(467
)
Prepaid expenses and other current assets
 
983

 
(3,663
)
Accounts payable
 
(4,729
)
 
(2,733
)
Accrued liabilities
 
1,523

 
1,316

Deferred revenue
 
20,442

 
(2,138
)
Net cash provided by operating activities
 
179,353

 
142,381

 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
Additions to property and equipment
 
(23,460
)
 
(37,734
)
Purchase of marketable security investments
 
(92,638
)
 
(49,905
)
Proceeds from marketable security investments
 
60,208

 
21,175

Cost of acquisitions, net of cash acquired
 
(167,308
)
 
(9,761
)
Decrease in other
 
857

 
418

Net cash used by investing activities
 
(222,341
)
 
(75,807
)
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
Decrease in net borrowings on revolving line of credit
 

 
(10,000
)
Purchase of treasury shares
 

 
(7,032
)
Proceeds from exercise of stock options
 
70,536

 
33,568

Contributions from employee stock purchase plan
 
5,978

 
5,342

Net cash provided by financing activities
 
76,514

 
21,878

 
 
 
 
 
Net increase in cash and cash equivalents
 
33,526

 
88,452

Cash and cash equivalents at beginning of period
 
185,926

 
36,151

Cash and cash equivalents at end of period
 
$
219,452

 
$
124,603

See accompanying notes.

4



Tyler Technologies, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Tables in thousands, except per share data)
 
 
(1) Basis of Presentation
We prepared the accompanying condensed consolidated financial statements following the requirements of the Securities and Exchange Commission (“SEC”) and accounting principles generally accepted in the United States, or GAAP, for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by GAAP can be condensed or omitted for interim periods. Balance sheet amounts are as of September 30, 2018, and December 31, 2017, and operating result amounts are for the three and nine months ended September 30, 2018, and 2017, respectively, and include all normal and recurring adjustments that we considered necessary for the fair summarized presentation of our financial position and operating results. As these are condensed financial statements, one should also read the financial statements and notes included in our latest Form 10-K for the year ended December 31, 2017. Revenues, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be the same as those for the full year.
Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions, and other events and circumstances from non-owner sources and includes all components of net income (loss) and other comprehensive income (loss). We had no items of other comprehensive income (loss) for the three and nine months ended September 30, 2018 and 2017.
Effective January 1, 2018, we adopted the requirements of Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers, utilizing the full retrospective approach as discussed in Note 2 - Accounting Standards and Significant Accounting Policies. All amounts and disclosures set forth in this Form 10-Q have been updated to comply with the new standard, as indicated by the "as adjusted" footnote.
(2) Accounting Standards and Significant Accounting Policies
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Except for the accounting policies for revenue recognition and deferred commissions that were adjusted as a result of adopting ASU No. 2014-09, there have been no changes to our significant accounting policies described in the Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on February 21, 2018, that have had a material impact on our condensed consolidated financial statements and related notes.
USE OF ESTIMATES
The preparation of our financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items subject to such estimates and assumptions include revenue recognition, determining the nature and timing of satisfaction of performance obligations, and determining the standalone selling price (“SSP”) of performance obligations, variable consideration, and other obligations such as returns and refunds; loss contingencies; the estimated useful life of deferred commissions; the carrying amount and estimated useful lives of intangible assets; determining share-based compensation expense; the valuation allowance for receivables; and determining the potential outcome of future tax consequences of events that have been recognized on our consolidated financial statements or tax returns. Actual results could differ from estimates.

5



REVENUE RECOGNITION
Nature of Products and Services
We provide integrated software systems and related services for the public sector, with a focus on local governments. We develop and market a broad line of software solutions and services to address the information technology (“IT”) needs of cities, counties, schools and other local government entities. In addition, we provide professional IT services, including software and hardware installation, data conversion, training, and for certain customers, product modifications, along with continuing maintenance and support for customers using our systems. We also provide subscription-based services such as software as a service (“SaaS”) arrangements, which utilize the Tyler private cloud, and electronic document filing solutions (“e-filing”). In addition, we provide property appraisal outsourcing services for taxing jurisdictions.
We earn revenue from software licenses, royalties, subscription-based services, software services, post-contract customer support (“PCS” or “maintenance”), hardware, and appraisal services. Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We determine revenue recognition through the following steps:
Identification of the contract, or contracts, with a customer
Identification of the performance obligations in the contract
Determination of the transaction price
Allocation of the transaction price to the performance obligations in the contract
Recognition of revenue when, or as, we satisfy a performance obligation
Most of our software arrangements with customers contain multiple performance obligations that range from software licenses, installation, training, and consulting to software modification and customization to meet specific customer needs (services), hosting, and PCS. For these contracts, we account for individual performance obligations separately when they are distinct. We evaluate whether separate performance obligations can be distinct or should be accounted for as one performance obligation. Arrangements that include software services, such as training or installation, are evaluated to determine whether those services are essential to the product’s functionality. The transaction price is allocated to the distinct performance obligations on a relative SSP basis. We determine the SSP based on our overall pricing objectives, taking into consideration market conditions and other factors, including the value of our contracts, the applications sold, customer demographics, and the number and types of users within our contracts. Revenue is recognized net of allowances for sales adjustments and any taxes collected from customers, which are subsequently remitted to governmental authorities.
Software Arrangements:
Software Licenses and Royalties
Many of our software arrangements involve “off-the-shelf” software. We recognize the revenue allocable to "off-the-shelf" software licenses and specified upgrades at a point in time when control of the software license transfers to the customer, unless the software is not considered distinct. We consider off-the-shelf software to be distinct when it can be added to an arrangement with minor changes in the underlying code, it can be used by the customer for the customer’s purpose upon installation and remaining services such as training are not considered essential to the product's functionality.
For arrangements that involve significant production, modification or customization of the software, or where software services are otherwise not considered distinct, we recognize revenue over time by measuring progress-to-completion. We measure progress-to-completion primarily using labor hours incurred as it best depicts the transfer of control to the customer which occurs as we incur costs on our contracts. These arrangements are often implemented over an extended period and occasionally require us to revise total cost estimates. Amounts recognized in revenue are calculated using the progress-to-completion measurement after giving effect to any changes in our cost estimates. Changes to total estimated contract costs, if any, are recorded in the period they are determined. Estimated losses on uncompleted contracts are recorded in the period in which we first determine that a loss is apparent.
Software license fees are billed in accordance with the contract terms. Typically, a majority of the fee is due when access to the software license is made available to the customer and the remainder of the fee due over a passage of time stipulated by the contract. 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.

6



We recognize royalty revenue when the sale occurs under the terms of our third-party royalty arrangements. Currently, our third-party royalties are recognized on an estimated basis and are trued up when we receive notice of amounts we are entitled to receive. Typically, we receive notice of royalty revenues we are entitled to and billed on a quarterly basis in the quarter immediately following the royalty reporting period.
Software Services
As noted above, some of our software arrangements include services considered essential or require significant customization to meet the customer's desired functionality. For these software arrangements, both the software licenses and related software services revenue are not distinct and are recognized over time using the progress-to-completion method. We measure progress-to-completion primarily using labor hours incurred as it best depicts the transfer of control to the customer which occurs as we incur costs on our contracts. Contract fees are typically billed on a milestone basis as defined within contract terms. 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. When software services are distinct, the fee allocable to the service element is recognized over the time we perform the services and is billed on a time and material basis.
Post-Contract Customer Support
Our customers generally enter into PCS agreements when they purchase our software licenses. PCS includes telephone support, bug fixes, and rights to upgrades on a when-and-if available basis. PCS is considered distinct when purchased with our software licenses. Our PCS agreements are typically renewable annually. PCS is recognized over time on a straight-line basis over the period the PCS is provided. All significant costs and expenses associated with PCS are expensed as incurred.
Computer Hardware Equipment
Revenue allocable to computer hardware equipment is recognized at a point in time when control of the equipment is transferred to the customer.
Subscription-Based Services:
Subscription-based services consist of revenues derived from SaaS arrangements, which utilize the Tyler private cloud, and electronic filing transactions. Revenue from subscription-based services is generally recognized over time on a ratable basis over the contract term, beginning on the date that our service is made available to the customer. Our subscription contracts are generally three to five years or longer in length, billed annually in advance, and non-cancelable.
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. We allocate contract value to each performance obligation of the arrangement that qualifies for treatment as a distinct element based on estimated SSP. When it is determined that software is distinct and the customer has the ability to take control of the software, we recognize revenue allocable to the software license fee when access to the software license is made available to the customer. We recognize hosting services ratably over the term of the arrangement, which range from one to ten years but are typically for a period of three to five years. For software services associated with certain SaaS arrangements, we have concluded that the services are not distinct, and we recognize the revenue ratably over the remaining contractual period once we have provided the customer access to the software. 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.
Electronic filing transaction fees primarily pertain to documents filed with the courts by attorneys and other third-parties via our e-filing services and retrieval of filed documents via our access services. For each document filed with a court, the filer generally pays a transaction fee and a court filing fee to us and we remit a portion of the transaction fee and the filing fee to the court. We record as revenue the transaction fee, while the portion of the transaction fee remitted to the courts is recorded as cost of sales as we are acting as a principal in the arrangement. Court filing fees collected on behalf of the courts and remitted to the courts are recorded on a net basis and thus do not affect the statement of comprehensive income. For e-filing transaction fees, we have the right to charge the customer an amount that directly corresponds with the value to the customer of our performance to date. Therefore, we recognize revenue for these services over time based on the amount billable to the customer in accordance with the 'as invoiced' practical expedient in ASC 606-10-55-18. In some cases, we are paid on a fixed fee basis and recognize the revenue ratably over the contractual period.

7



Costs of performing services under subscription-based arrangements are expensed as incurred, except for certain direct and incremental contract origination and set-up costs associated with SaaS arrangements. Such direct and incremental costs are capitalized and amortized ratably over the useful life.
Appraisal Services:
For our property appraisal projects, we recognize revenue using the progress-to-completion method since many of these projects are implemented over one to three-year periods and consist of various unique activities. Appraisal services require a significant level of integration and interdependency with various individual service components; therefore, the service components are not considered distinct. Appraisal services are recognized over time by measuring progress-to-completion primarily using labor hours incurred as it best depicts the transfer of control to the customer which occurs as we incur costs on our contracts. These arrangements are often implemented over an extended period and occasionally require us to revise total cost estimates. Amounts recognized in revenue are calculated using the progress-to-completion measurement after giving effect to any changes in our cost estimates. Changes to total estimated contract costs, if any, are recorded in the period they are determined. Estimated losses on uncompleted contracts are recorded in the period in which we first determine that a loss is apparent. Contract fees are typically billed on a milestone basis as defined within contract terms. 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.
Significant Judgments:
Our contracts with customers often include multiple performance obligations to a customer. When a software arrangement (traditional or subscription) includes both software licenses and software services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the software services and recognized over time.
The transaction price is allocated to the separate performance obligations on a relative SSP basis. We determine the SSP based on our overall pricing objectives, taking into consideration market conditions and other factors, including the value of our contracts, the applications sold, customer demographics, and the number and types of users within our contracts. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine SSP using the expected cost-plus margin approach.
For arrangements that involve significant production, modification or customization of the software, or where software services otherwise cannot be considered distinct, we recognize revenue as control is transferred to the customer over time using progress-to-completion methods. Depending on the contract, we measure progress-to-completion primarily using labor hours incurred, or value added. The progress-to-completion method generally results in the recognition of reasonably consistent profit margins over the life of a contract because we can provide reasonably dependable estimates of contract billings and contract costs. We use the level of profit margin that is most likely to occur on a contract. If the most likely profit margin cannot be precisely determined, the lowest probable level of profit margin in the range of estimates is used until the results can be estimated more precisely. These arrangements are often implemented over an extended time period and occasionally require us to revise total cost estimates. Amounts recognized in revenue are calculated using the progress-to-completion measurement after giving effect to any changes in our cost estimates. Changes to total estimated contract costs, if any, are recorded in the period they are determined. Estimated losses on uncompleted contracts are recorded in the period in which we first determine that a loss is apparent.
Typically, the structure of our arrangements does not give rise to variable consideration. However, in those instances whereby variable consideration exists, we include in our estimates additional revenue for variable consideration when we believe we have an enforceable right, the amount can be estimated reliably and its realization is probable.
Refer to Note 12 - Disaggregation of Revenue for further information, including the economic factors that affect the nature, amount, timing, and uncertainty of revenue and cash flows of our various revenue categories.

8



Contract Balances: 
Accounts receivable and allowance for doubtful accounts
Timing of revenue recognition may differ from the timing of invoicing to customers. We record an unbilled receivable when revenue is recognized prior to invoicing, or deferred revenue when revenue is recognized subsequent to invoicing. For multi-year agreements, we generally invoice customers annually at the beginning of each annual coverage period. We record an unbilled receivable related to revenue recognized for on-premises licenses as we have an unconditional right to invoice and receive payment in the future related to those licenses.
We maintain allowances for doubtful accounts, which are provided at the time the revenue is recognized. Since most of our customers are domestic governmental entities, we rarely incur a loss resulting from the inability of a customer to make required payments. Events or changes in circumstances that indicate the carrying amount for the allowances for doubtful accounts 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.
The following table summarizes the changes in the allowance for doubtful accounts:
 
September 30, 2018
Balance, beginning of period December 31, 2017
$
5,427

Provisions for losses - accounts receivable
1,714

Collection of accounts previously written off
(212
)
Deductions for accounts charged off or credits issued
(1,819
)
Balance, end of period
$
5,110

The allowance for doubtful accounts reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence.
In connection with our appraisal services contracts and certain software services contracts, we may perform work prior to when the software and services are billable and/or payable pursuant to the contract. Unbilled revenue is not billable at the balance sheet date but is recoverable over the remaining life of the contract through billings made in accordance with contractual agreements. The termination clauses in most of our contracts provide for the payment for the value of products delivered or services performed in the event of early termination. We have historically recorded such unbilled receivables (costs and estimated profit in excess of billings) in connection with (1) property appraisal services contracts accounted for using progress-to-completion method of revenue recognition using labor hours as a measure of progress towards completion in which the services are performed in one accounting period but the billing normally occurs subsequently and may span another accounting period; (2) software services contracts accounted for using progress-to-completion method of revenue recognition using labor hours as a measure of progress towards completion in which the services are performed in one accounting period but the billing for the software element of the arrangement may be based upon the specific phase of the implementation; (3) software revenue for which we have recognized revenue at the point in time when the software is made available to the customer but the billing has not yet been submitted to the customer; (4) some of our contracts which provide for an amount to be withheld from a progress billing (generally between 5% and 20% retention) until final and satisfactory project completion is achieved; and (5) in a limited number of cases, extended payment terms, which may be granted to customers with whom we generally have a long-term relationship and favorable collection history.
The opening balance of current and long-term accounts receivable, net of allowance for doubtful accounts, was $226.8 million (as adjusted) as of January 1, 2017.

9



As of September 30, 2018, and December 31, 2017, total current and long-term accounts receivable, net of allowance for doubtful accounts, was $294.5 million and $258.3 million (as adjusted), respectively. We have recorded unbilled receivables of $86.9 million and $64.6 million (as adjusted) at September 30, 2018, and December 31, 2017, respectively. Included in unbilled receivables are retention receivables of $8.3 million and $7.2 million at September 30, 2018, and December 31, 2017, respectively, which become payable upon the completion of the contract or completion of our fieldwork and formal hearings. Unbilled receivables expected to be collected within one year have been included with accounts receivable, current portion in the accompanying condensed consolidated balance sheets. Unbilled receivables and retention receivables expected to be collected past one year have been included with accounts receivable, long-term portion in the accompanying condensed consolidated balance sheets.
Payment terms and conditions vary by contract type, although, terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and multi-year on-premises term licenses that are invoiced annually with revenue recognized upfront.
Deferred Revenue
The majority of deferred revenue consists of deferred maintenance revenue that has been billed based on contractual terms in the underlying arrangement, with the remaining balance consisting of payments received in advance of revenue being earned under software licensing, subscription-based services, software and appraisal services and hardware installation. Refer to Note 13 - Deferred Revenue and Performance Obligations for further information, including deferred revenue by segment and changes in deferred revenue during the period.
Deferred Commissions
Sales commissions earned by our sales force are considered incremental and recoverable costs of obtaining a contract with a customer. Sales commissions for initial contracts are deferred and then amortized on a straight-line basis over a period of benefit that we have determined to be three to seven years. We utilized the 'portfolio approach' practical expedient in ASC 606-10-10-4, which allows entities to apply the guidance to a portfolio of contracts with similar characteristics because the effects on the financial statements of this approach would not differ materially from applying the guidance to individual contracts. Using the 'portfolio approach', we determined the period of benefit by taking into consideration our customer contracts, our technology life-cycle and other factors. Sales commissions for renewal contracts are generally not paid in connection with the renewal of a contract. In the small number of instances where a commission is paid on a renewal, it is not commensurate with the commission paid on the initial sale and is recognized over the term of renewal, which is generally one year. Amortization expense related to deferred commissions is included in selling, general and administrative expenses in the accompanying condensed consolidated statements of income. Refer to Note 5 - Deferred Commissions for further information.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

Revenue from Contracts with Customers. In May 2014, the Financial Accounting Standards Board ("FASB") issued ASU No. 2014-09, Revenue from Contracts with Customers. ASU No. 2014-09 supersedes the revenue recognition requirements in Accounting Standards Codification ("ASC") Topic 605, Revenue Recognition ("Topic 605"), and requires the recognition of revenue when promised goods or services are transferred to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or 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. Topic 606 also includes Subtopic 340-40 Other Assets and Deferred Costs - Contracts with Customers, which requires the deferral of incremental costs of obtaining a contract with a customer. Collectively, we refer to ASU No. 2014-09 and Subtopic 340-40 as the "new standard."

We adopted the requirements of the new standard as of January 1, 2018, utilizing the full retrospective method of transition. Adoption of the new standard resulted in changes to our accounting policies for revenue recognition, trade and other receivables, and deferred commissions as detailed below. We applied the new standard using a practical expedient where the consideration allocated to the remaining performance obligations or an explanation of when we expect to recognize that amount as revenue for all reporting periods presented before the date of the initial application is not disclosed.


10



The impact of adopting ASU No. 2014-09 on our total revenues for 2017 and 2016 was not material. The impact of adopting the new standard on our retained earnings and deferred commissions is material. The most significant impact of the new standard relates to our accounting for software license revenue. Specifically, under the new standard, software license fees under perpetual agreements are no longer subject to 100% discount allocations from other performance obligations in the contract. Discounts in arrangements are allocated across all performance obligations 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) are recognized at the point in time when control of the software license transfers to the customer versus our legacy policy of recognizing revenue upon delivery and only to the extent billable per the contractual terms. Under the new standard, time-based license fees are no longer recognized over the contractual period of the license and are instead recognized at the point in time when the control of the software license transfers to the customer. Revenues related to our PCS renewals, SaaS offerings and appraisal services remain substantially unchanged. Due to the complexity of certain contracts, the actual revenue recognition treatment required under the new standard is dependent on contract-specific terms and may vary in some instances from recognition at the time of billing.

Adoption of the new standard requires that incremental costs directly related to obtaining a contract (typically sales commissions) 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. Prior to adoption of the new standard, we deferred sales commissions and recognized expense over the relevant initial contractual term, which was generally one to two years. Under the new standard, we amortize these costs over a period of benefit that we have determined to be three to seven years.

We adjusted our condensed consolidated financial statements from amounts previously reported due to the adoption of the new standard. Select unaudited condensed consolidated statement of income line items, which reflect the adoption of the new standard, are as follows (in thousands, except per share data):

 
 
Three Months Ended September 30, 2017
 
Nine Months Ended September 30, 2017
 
 
As Reported
 
Adjustments
 
As Adjusted
 
As Reported
 
Adjustments
 
As Adjusted
Statement of Income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Software licenses and royalties
 
$
19,842

 
$
2,920

 
$
22,762

 
$
55,172

 
$
8,654

 
$
63,826

Subscriptions
 
44,840

 
(488
)
 
44,352

 
125,889

 
(1,158
)
 
124,731

Software services
 
47,479

 
(1,434
)
 
46,045

 
139,869

 
(5,468
)
 
134,401

Maintenance
 
92,285

 
(438
)
 
91,847

 
268,556

 
(1,591
)
 
266,965

Appraisal services
 
6,290

 

 
6,290

 
19,268

 

 
19,268

Hardware and other
 
3,410

 

 
3,410

 
14,057

 
(50
)
 
14,007

Total revenues
 
214,146

 
560

 
214,706

 
622,811

 
387

 
623,198

Selling, general and administrative expenses
 
44,656

 
(143
)
 
44,513

 
131,249

 
(956
)
 
130,293

Amortization of customer and trade name intangibles
 
3,492

 
(132
)
 
3,360

 
10,413

 
(397
)
 
10,016

Operating income
 
43,447

 
835

 
44,282

 
116,671

 
1,740

 
118,411

Income tax provision
 
5,259

 
262

 
5,521

 
14,308

 
512

 
14,820

Net income
 
$
38,263

 
$
573

 
$
38,836

 
$
102,147

 
$
1,228

 
$
103,375

 
 
 
 
 
 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
$
1.02

 
 
 
$
1.04

 
$
2.74

 
 
 
$
2.78

Diluted
 
$
0.97

 
 
 
$
0.99

 
$
2.60

 
 
 
$
2.63


11



Select condensed consolidated balance sheet line items, which reflect the adoption of the new standard, are as follows (in thousands):
 
December 31, 2017
 
As Reported
 
Adjustments
 
As Adjusted
Balance Sheet:
 
 
 
 
 
 
 
 
 
 
 
Accounts receivable
$
227,127

 
$
19,061

 
$
246,188

Prepaid expenses
27,252

 
4,954

 
32,206

Accounts receivable, long-term
7,536

 
4,571

 
12,107

Other intangibles, net
236,444

 
(6,827
)
 
229,617

Total assets
1,589,592

 
21,759

 
1,611,351

Deferred revenue
309,461

 
(10,848
)
 
298,613

Deferred income taxes
38,914

 
7,965

 
46,879

Retained earnings
599,821

 
24,642

 
624,463

Total liabilities and shareholders' equity
$
1,589,592

 
$
21,759

 
$
1,611,351


Our adoption of ASU No. 2014-09 had no impact on our net cash provided by or used in operating, investing or financing activities for any of the periods reported.
Recent tax legislation. On December 22, 2017, the Tax Cuts and Jobs Act ("Tax Act") was enacted into law. The Tax Act amends the Internal Revenue Code to reduce tax rates and modify policies, credits and deductions for businesses and individuals. For businesses, the Tax Act reduces the U.S. corporate federal income tax rate from a maximum of 35% to a flat 21% rate and transitions from a worldwide tax system to a territorial tax system. The Tax Act also adds many new provisions including changes to bonus depreciation, the deduction for executive compensation and a tax on global intangible low-taxed income (GILTI). The most significant impact of the Tax Act to us is the reduction in the U.S. federal corporate income tax rate. Refer to Note 8 - Income Tax Provision for further information.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
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 (except for short-term leases) at the commencement date:
A lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and
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.
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.  
Topic 842 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.  

12



(3) Acquisitions

On August 31, 2018, we acquired all of the assets of CaseloadPRO, L.P. ("CaseloadPRO"), a company that provides a fully featured probation case management system. The purchase price was $9.2 million, of which $9.1 million was paid in cash and approximately $150,000 was accrued as of September 30, 2018. The impact of this acquisition on our operating results is not material.

On April 30, 2018, we acquired all of the equity interests of Sage Data Security, LLC ("Sage"), a cybersecurity company offering a suite of services that supports an entire cybersecurity lifecycle, including program development, education and training, technical testing, advisory services, and digital forensics. The total purchase price was $11.6 million paid in cash. The impact of this acquisition on our operating results is not material.

On April 30, 2018, we acquired all of the capital stock of Socrata, Inc. ("Socrata"), a company that provides open data and data-as-a-service solutions including cloud-based data integration, visualization, analysis, and reporting solutions for state and local government agencies.  The purchase price, net of cash acquired of $1.7 million, was $147.6 million paid in cash.

We have performed a preliminary valuation analysis of the fair market value of Socrata’s assets and liabilities. The following table summarizes the allocation of the preliminary purchase price as of the acquisition date.

 
 
 
Cash
 
$
1,724

Accounts receivable
 
3,616

Other current assets
 
2,057

Other noncurrent assets
 
68

Identifiable intangible assets
 
75,000

Goodwill
 
78,909

Accounts payable
 
(1,254
)
Accrued expenses
 
(1,717
)
Deferred revenue
 
(5,915
)
Deferred tax liabilities, net
 
(3,120
)
Total consideration
 
$
149,368


In connection with this transaction, we acquired total tangible assets of $7.5 million and assumed liabilities of approximately $8.9 million. We recorded goodwill of $78.9 million, none of which is expected to be deductible for tax purposes, and other identifiable intangible assets of approximately $75.0 million. The $75.0 million of intangible assets are attributable to customer relationships, acquired software, and trade name and will be amortized over a weighted average period of approximately 14 years. We recorded deferred tax liabilities of $3.1 million related to estimated fair value allocations. Socrata’s solutions are a direct complement to our current offerings and will provide a new and important additional revenue stream. By offering Socrata within virtually every Tyler product suite, our clients will have the opportunity to make their existing data discoverable, usable and actionable, but more importantly, potentially include data from other agencies and jurisdictions to make analysis even more powerful and meaningful. Therefore, the goodwill of $78.9 million arising from this acquisition is primarily attributed to our ability to integrate Socrata's solutions with our existing portfolio and to generate increased revenues, earnings and cash flow by leveraging our sales resources and client base. We also incurred fees of approximately $578,000 for financial advisory, legal, accounting, due diligence, valuation and other various services necessary to complete the acquisition. These fees were expensed in 2018 and are included in selling, general and administrative expenses.

13




The following unaudited pro forma information of the consolidated results of operations have been prepared as if the Socrata acquisition had occurred at January 1, 2017, after giving effect to certain adjustments, including amortization of intangibles, interest, transaction costs and tax effects.
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
Revenues
 
$
236,067

 
$
220,825

 
$
701,742

 
$
642,034

Net income
 
38,924

 
34,119

 
107,763

 
89,599

Basic earnings per share
 
1.00

 
0.91

 
2.80

 
2.41

Diluted earnings per share
 
$
0.96

 
$
0.87

 
$
2.67

 
$
2.28


Pro forma information above does not include acquisitions that are not considered material to our results of operations. The pro forma information does not purport to represent what our results of operations actually would have been had such transaction or event occurred on the date specified or to project our results of operations for any future period.

As of September 30, 2018, the purchase price allocations for Socrata, Sage and CaseloadPRO are not yet complete. The preliminary estimates of fair value assumed at the acquisition date for intangible assets, receivables and deferred revenue and related deferred taxes are subject to change as valuations are finalized. The operating results of Socrata, Sage and CaseloadPRO are included with the operating results of the Enterprise Software segment since their date of acquisition. Revenues from Socrata included in Tyler's results of operations were approximately $5.4 million and $8.4 million and the net losses were $3.9 million and $7.9 million for both the three and nine months ended September 30, 2018, respectively. Revenues and operating results from Sage and CaseloadPRO included in 2018 results were not significant.
Our balance sheet as of September 30, 2018, reflects the allocation of the purchase price to the assets acquired based on their fair value at the date of each acquisition. The fair value of the assets and liabilities acquired are based on valuations using Level III, unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.


(4) Shareholders’ Equity

The following table details activity in our common stock:
 
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
 
Shares
 
Amount
 
Shares
 
Amount
Purchases of treasury shares
 

 
$

 
(42
)
 
$
(6,171
)
Stock option exercises
 
1,048

 
70,536

 
787

 
33,568

Employee stock plan purchases
 
35

 
$
5,978

 
40

 
$
5,342

As of September 30, 2018, we had authorization from our board of directors to repurchase up to 2.0 million additional shares of Tyler common stock.
  

14



(5) Deferred Commissions

Sales commissions earned by our sales force are considered incremental and recoverable costs of obtaining a contract with a customer. Sales commissions for initial contracts are deferred and then amortized commensurate with the recognition of associated revenue over a period of benefit that we have determined to be three to seven years. Deferred commissions were $21.4 million and $19.3 million (as adjusted) as of September 30, 2018, and December 31, 2017, respectively. Amortization expense was $3.8 million and $10.9 million for the three and nine months ended September 30, 2018, respectively, and $2.6 million and $7.9 million for the three and nine months ended September 30, 2017 (as adjusted), respectively. There were no indicators of impairment in relation to the costs capitalized for the periods presented. Deferred commissions have been included with prepaid expenses in the accompanying condensed consolidated balance sheets. Amortization expense related to deferred commissions is included in selling, general and administrative expenses in the accompanying condensed consolidated statements of income.

(6) Other Assets

Cash and cash equivalents consist of cash on deposit with several domestic banks and money market funds.
As of September 30, 2018, we have $95.8 million in investment grade corporate and municipal bonds with maturity dates ranging through 2022. We intend to hold these bonds to maturity and have classified them as such. We believe cost approximates fair value because of the relatively short duration of these investments. The fair values of these securities are considered Level II as they are based on inputs from quoted prices in markets that are not active or other observable market data. These investments are included in short-term investments and non-current investments and other assets.
 
We have a $15.0 million investment in convertible preferred stock representing a 20% interest in Record Holdings Pty Limited, a privately held Australian company specializing in digitizing the spoken word in court and legal proceedings. The investment in convertible preferred stock is accounted under the cost method because we do not have the ability to exercise significant influence over the investee and the securities do not have readily determinable fair values. Our investment is carried at cost less any impairment write-downs. Annually, our cost method investments are assessed for impairment. We do not reassess the fair value of cost method investments if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investments. This investment is included in non-current investments and other assets.

(7) Revolving Line of Credit

On November 16, 2015, we entered into a $300 million credit agreement with various lender parties and Wells Fargo Bank, National Association, as Administrative Agent (the “Credit Facility”). The Credit Facility provides for a revolving credit line up to $300 million, including a $10 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 September 30, 2018, the interest rates were 5.25% under the Wells Fargo Bank's prime rate and 3.49% under a 30-day LIBOR contract. 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 September 30, 2018, we were in compliance with those covenants.
 
As of September 30, 2018, we had no outstanding borrowings. Available borrowing capacity under the Credit Facility was $300 million.
 

15



(8) Income Tax Provision

We had an effective income tax rate of negative 0.8% and 0.1% for the three and nine months ended September 30, 2018, respectively, compared to 12.4% and 12.5% (as adjusted) for the three and nine months ended September 30, 2017, respectively. The effective income tax rates for the periods presented were different from the statutory United States federal income tax rate of 21% in 2018 and 35% in 2017 principally due to excess tax benefits related to stock option exercises. The excess tax benefit related to stock option exercises realized was $9.3 million and $30.0 million for the three and nine months ended September 30, 2018, respectively, compared to $9.0 million and $27.6 million for the three and nine months ended September 30, 2017, respectively. Excluding the excess tax benefits, the effective rate was 23.3% and 25.8% for the three and nine months ended September 30, 2018, respectively, compared to 32.8% and 35.9% (as adjusted) for the three and nine months ended September 30, 2017, respectively. Other differences from the federal statutory income tax rate include state income taxes, non-deductible business expenses, the tax benefit of research tax credits, provisional amounts associated with the Tax Act recorded in 2018, and in 2017, the tax benefit of the domestic production activities deduction.

The decrease in effective tax rate for the three and nine months ended September 30, 2018, as compared to the same periods in 2017 was due primarily to the reduction of the U.S. corporate tax rate from 35% to 21% as a result of the Tax Act, the increase in excess tax benefit related to stock option exercises and the research tax credit benefit, offset by the elimination of the domestic production activities deduction and the increased limitations on the deduction for executive compensation. In the fourth quarter of 2017, we recorded a $26.0 million (as adjusted under Topic 606) tax benefit due to the remeasurement of deferred tax assets and liabilities at a lower tax rate. As of September 30, 2018, we increased the provisional amounts for the income tax effects of the Tax Act recorded in 2017 to $27.7 million to reflect actual amounts reported in income tax returns filings. We will continue to analyze the estimates and further guidance on the application of the law, and additional revisions may occur throughout the allowable measurement period which will not exceed one year from the enactment of the Tax Act. Overall, the changes due to the Tax Act will favorably affect income tax expense and future U.S. earnings. 
We made tax payments of $6.8 million and $29.0 million in the nine months ended September 30, 2018, and 2017, respectively.
 
(9) Earnings Per Share

The following table details the reconciliation of basic earnings per share to diluted earnings per share:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
 
 
As Adjusted
 
 
 
As Adjusted
Numerator for basic and diluted earnings per share:
 
 
 
 
 
 
 
 
Net income
 
$
38,924

 
$
38,836

 
$
115,910

 
$
103,375

Denominator:
 
 

 
 

 


 


Weighted-average basic common shares outstanding
 
38,761

 
37,391

 
38,533

 
37,238

Assumed conversion of dilutive securities:
 
 
 
 
 

 

Stock options
 
1,767

 
1,951

 
1,812

 
2,028

Denominator for diluted earnings per share
   - Adjusted weighted-average shares
 
40,528

 
39,342

 
40,345

 
39,266

Earnings per common share:
 
 

 
 

 


 


Basic
 
$
1.00

 
$
1.04

 
$
3.01

 
$
2.78

Diluted
 
$
0.96

 
$
0.99

 
$
2.87

 
$
2.63

 
For the three and nine months ended September 30, 2018, stock options representing the right to purchase common stock of approximately 350,000 and 734,000 shares were not included in the computation of diluted earnings per share because their inclusion would have had an anti-dilutive effect. For the three and nine months ended September 30, 2017, stock options representing the right to purchase common stock of approximately 1,499,000 and 1,303,000 shares were not included in the computation of diluted earnings per share because their inclusion would have had an anti-dilutive effect. 

 

16



(10) Share-Based Compensation

The following table summarizes share-based compensation expense related to share-based awards recorded in the condensed consolidated statements of income, pursuant to ASC 718, Stock Compensation:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Cost of software services, maintenance and subscriptions
 
$
3,909

 
$
2,524

 
$
9,640

 
$
6,874

Selling, general and administrative expenses
 
10,567

 
7,267

 
28,326

 
20,494

Total share-based compensation expense
 
$
14,476

 
$
9,791

 
$
37,966

 
$
27,368

 
(11) Segment and Related Information

We provide integrated information management solutions and services for the public sector, with a focus on local governments.
We provide our software systems and services and appraisal services through five business units, which focus on the following products:
financial management, education and planning, regulatory and maintenance software solutions;
financial management, municipal courts, planning, regulatory and maintenance, and land and vital records management software solutions;
courts and justice and public safety software solutions;
data and insights solutions; and
appraisal and tax software solutions and property appraisal services.
In accordance with ASC 280-10, Segment Reporting, the financial management, education and planning, regulatory and maintenance software solutions unit; financial management, municipal courts, planning, regulatory and maintenance, and land and vital records management software solutions unit; courts and justice and public safety software solutions unit; and the data and insights solutions unit meet the criteria for aggregation and are presented in one reportable segment, the Enterprise Software (“ES”) segment. The 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 and courts and justice processes; public safety; planning, regulatory and maintenance; land and vital records management, and data analytics. 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.
We evaluate performance based on several factors, of which the primary financial measure is business segment operating income. We define segment operating income for our business units as income before non-cash amortization of intangible assets associated with their acquisitions, interest expense and income taxes. Segment operating income includes intercompany transactions. The majority of intercompany transactions relate to contracts involving more than one unit and are valued based on the contractual arrangement. Segment operating income for corporate primarily consists of compensation costs for the executive management team and certain accounting and administrative staff and share-based compensation expense for the entire company. Corporate segment operating income also includes revenues and expenses related to a company-wide user conference.

17



For the three months ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
Enterprise
Software
 
Appraisal and Tax
 
Corporate
 
Totals
Revenues
 
 
 
 
 
 
 
 
Software licenses and royalties
 
$
19,544

 
$
2,900

 
$

 
$
22,444

Subscriptions
 
56,220

 
2,479

 

 
58,699

Software services
 
41,640

 
6,559

 

 
48,199

Maintenance
 
90,072

 
6,143

 

 
96,215

Appraisal services
 

 
5,544

 

 
5,544

Hardware and other
 
4,999

 

 
(33
)
 
4,966

Intercompany
 
3,373

 

 
(3,373
)
 

Total revenues
 
$
215,848

 
$
23,625

 
$
(3,406
)
 
$
236,067

Segment operating income
 
$
59,334

 
$
6,695

 
$
(18,161
)
 
$
47,868



For the nine months ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
Enterprise Software
 
Appraisal and Tax
 
Corporate
 
Totals
Revenues
 
 
 
 
 
 
 
 
Software licenses and royalties
 
$
60,224

 
$
7,396

 
$

 
$
67,620

Subscriptions
 
153,541

 
7,195

 

 
160,736

Software services
 
126,928

 
17,884

 

 
144,812

Maintenance
 
267,681

 
18,507

 

 
286,188

Appraisal services
 

 
16,470

 

 
16,470

Hardware and other
 
12,525

 
33

 
4,917

 
17,475

Intercompany
 
9,696

 

 
(9,696
)
 

Total revenues
 
$
630,595

 
$
67,485

 
$
(4,779
)
 
$
693,301

Segment operating income
 
$
174,365

 
$
16,845

 
$
(48,900
)
 
$
142,310




For the three months ended September 30, 2017
 
 
 
 
 
 
 
 
As Adjusted
 
Enterprise
Software
 
Appraisal and Tax
 
Corporate
 
Totals
Revenues
 
 
 
 
 
 
 
 
Software licenses and royalties
 
$
21,143

 
$
1,619

 
$

 
$
22,762

Subscriptions
 
42,338

 
2,014

 

 
44,352

Software services
 
40,861

 
5,184

 

 
46,045

Maintenance
 
86,138

 
5,709

 

 
91,847

Appraisal services
 

 
6,290

 

 
6,290

Hardware and other
 
3,412

 

 
(2
)
 
3,410

Intercompany
 
2,660

 

 
(2,660
)
 

Total revenues
 
$
196,552

 
$
20,816

 
$
(2,662
)
 
$
214,706

Segment operating income
 
$
61,243

 
$
5,450

 
$
(13,578
)
 
$
53,115




18



For the nine months ended September 30, 2017
 
 
 
 
 
 
 
 
As Adjusted
 
Enterprise
Software
 
Appraisal and Tax
 
Corporate
 
Totals
Revenues
 
 
 
 
 
 
 
 
Software licenses and royalties
 
$
58,805

 
$
5,021

 
$

 
$
63,826

Subscriptions
 
119,033

 
5,698

 

 
124,731

Software services
 
120,190

 
14,211

 

 
134,401

Maintenance
 
251,457

 
15,508

 

 
266,965

Appraisal services
 

 
19,268

 

 
19,268

Hardware and other
 
9,385

 

 
4,622

 
14,007

Intercompany
 
7,309

 

 
(7,309
)
 

Total revenues
 
$
566,179

 
$
59,706

 
$
(2,687
)
 
$
623,198

Segment operating income
 
$
167,767

 
$
14,371

 
$
(37,468
)
 
$
144,670


 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Reconciliation of reportable segment operating income to the Company's consolidated totals:
 
2018
 
2017
 
2018
 
2017
 
 
 
 
As Adjusted
 
 
 
As Adjusted
Total segment operating income
 
$
47,868

 
$
53,115

 
$
142,310

 
$
144,670

Amortization of acquired software
 
(5,897
)
 
(5,473
)
 
(17,003
)
 
(16,243
)
Amortization of customer and trade name intangibles
 
(4,386
)
 
(3,360
)
 
(11,742
)
 
(10,016
)
Other income (expense), net
 
1,041

 
75

 
2,198

 
(216
)
Income before income taxes
 
$
38,626

 
$
44,357

 
$
115,763

 
$
118,195

 

19




(12) Disaggregation of Revenue
The tables below show disaggregation of revenue into categories that reflect how economic factors affect the nature, amount, timing, and uncertainty of revenue and cash flows.
Timing of Revenue Recognition
Timing of revenue recognition by revenue category during the period is as follows:
For the three months ended September 30, 2018
 
 
 
 
 
 
 
 
Products and services transferred at a point in time
 
Products and services transferred over time
 
Total
Revenues
 
 
 
 
 
 
Software licenses and royalties
 
$
17,373

 
$
5,071

 
$
22,444

Subscriptions
 

 
58,699

 
58,699

Software services
 

 
48,199

 
48,199

Maintenance
 

 
96,215

 
96,215

Appraisal services
 

 
5,544

 
5,544

Hardware and other
 
4,966

 

 
4,966

Total
 
$
22,339

 
$
213,728

 
$
236,067

For the nine months ended September 30, 2018
 
 
 
 
 
 
 
 
Products and services transferred at a point in time
 
Products and services transferred over time
 
Total
Revenues
 
 
 
 
 
 
Software licenses and royalties
 
$
53,697

 
$
13,923

 
$
67,620

Subscriptions
 

 
160,736

 
160,736

Software services
 

 
144,812

 
144,812

Maintenance
 

 
286,188

 
286,188

Appraisal services
 

 
16,470

 
16,470

Hardware and other
 
17,475

 

 
17,475

Total
 
$
71,172

 
$
622,129

 
$
693,301




20



For the three months ended September 30, 2017
 
 
 
 
 
 
 As Adjusted
 
Products and services transferred at a point in time
 
Products and services transferred over time
 
Total
Revenues
 
 
 
 
 
 
Software licenses and royalties
 
$
18,007

 
$
4,755

 
$
22,762

Subscriptions
 

 
44,352

 
44,352

Software services
 

 
46,045

 
46,045

Maintenance
 

 
91,847

 
91,847

Appraisal services
 

 
6,290

 
6,290

Hardware and other
 
3,410

 

 
3,410

Total
 
$
21,417

 
$
193,289

 
$
214,706


For the nine months ended September 30, 2017
 
 
 
 
 
 
 As Adjusted
 
Products and services transferred at a point in time
 
Products and services transferred over time
 
Total
Revenues
 
 
 
 
 
 
Software licenses and royalties
 
$
51,257

 
$
12,569

 
$
63,826

Subscriptions
 

 
124,731

 
124,731

Software services
 

 
134,401

 
134,401

Maintenance
 

 
266,965

 
266,965

Appraisal services
 

 
19,268

 
19,268

Hardware and other
 
14,007

 

 
14,007

Total
 
$
65,264

 
$
557,934

 
$
623,198

Recurring Revenue
The majority of our revenue is comprised of recurring revenues from maintenance and subscriptions. Virtually all of our on-premises software clients contract with us for maintenance and support, which provides us with a significant source of recurring revenue. We generally provide maintenance and support for our on-premises clients under annual, or in some cases, multi-year contracts. The contract terms for subscription arrangements range from one to 10 years but are typically contracted for initial periods of three to five years, providing a significant source of recurring revenues on an annual basis. Non-recurring revenues are derived for all other revenue categories.
Recurring revenues and non-recurring revenues recognized during the period are as follows:
For the three months ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
Enterprise
Software
 
Appraisal and Tax
 
Corporate
 
Totals
 
 
 
 
 
 
 
 
 
Recurring revenues
 
$
146,292

 
$
8,622

 
$

 
$
154,914

Non-recurring revenues
 
66,183

 
15,003

 
(33
)
 
81,153

Intercompany
 
3,373

 

 
(3,373
)
 

Total revenues
 
$
215,848

 
$
23,625

 
$
(3,406
)
 
$
236,067




21



For the nine months ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
Enterprise
Software
 
Appraisal and Tax
 
Corporate
 
Totals
 
 
 
 
 
 
 
 
 
Recurring revenues
 
$
421,222

 
$
25,702

 
$

 
$
446,924

Non-recurring revenues
 
199,677

 
41,783

 
4,917

 
246,377

Intercompany
 
9,696

 

 
(9,696
)
 

Total revenues
 
$
630,595

 
$
67,485

 
$
(4,779
)
 
$
693,301



For the three months ended September 30, 2017
 
 
 
 
 
 
 
 
As Adjusted
 
Enterprise
Software
 
Appraisal and Tax
 
Corporate
 
Totals
 
 
 
 
 
 
 
 
 
Recurring revenues
 
$
128,476

 
$
7,723

 
$

 
$
136,199

Non-recurring revenues
 
65,416

 
13,093

 
(2
)
 
78,507

Intercompany
 
2,660

 

 
(2,660
)
 

Total revenues
 
$
196,552

 
$
20,816

 
$
(2,662
)
 
$
214,706


For the nine months ended September 30, 2017
 
 
 
 
 
 
 
 
As Adjusted
 
Enterprise
Software
 
Appraisal and Tax
 
Corporate
 
Totals
 
 
 
 
 
 
 
 
 
Recurring revenues
 
$
370,490

 
$
21,206

 
$

 
$
391,696

Non-recurring revenues
 
188,380

 
38,500

 
4,622

 
231,502

Intercompany
 
7,309

 

 
(7,309
)
 

Total revenues
 
$
566,179

 
$
59,706

 
$
(2,687
)
 
$
623,198



(13) Deferred Revenue and Performance Obligations
Total deferred revenue, including long-term, by segment is as follows:
 
 
September 30, 2018
 
December 31, 2017
 
 
 
 
As Adjusted
Enterprise Software
 
$
307,872

 
$
277,198

Appraisal and Tax
 
16,450

 
20,387

Corporate
 
2,592

 
2,302

Totals
 
$
326,914

 
$
299,887

The opening balance of total deferred revenue, including long-term, was $290.1 million (as adjusted) as of January 1, 2017.
 
Changes in total deferred revenue, including long-term, were as follows:

 
 
September 30, 2018
Balance, beginning of period December 31, 2017 (As Adjusted)
 
$
299,887

Deferral of revenue
 
649,152

Recognition of deferred revenue
 
(622,125
)
Balance, end of period
 
$
326,914


22




Transaction Price Allocated to the Remaining Performance Obligations

The aggregate amount of transaction price allocated to the remaining performance obligations represents contracted revenue that has not yet been recognized ("Backlog"), which includes deferred revenue and amounts that will be invoiced and recognized as revenue in future periods. Backlog as of September 30, 2018 was $1.2 billion, of which we expect to recognize approximately 51% as revenue over the next 12 months and the remainder thereafter.


(14) Commitments and Contingencies

Other than routine litigation incidental to our business, there are no material legal proceedings pending to which we are party or to which any of our properties are subject.
 
(15) Subsequent Events

The following events and transactions occurred subsequent to September 30, 2018:

On October 1, 2018, we acquired all of the capital stock of TradeMaster, Inc. dba MobileEyes, a company that develops software to improve public safety by supporting fire prevention and suppression, emergency response, and structural safety. The total purchase price was approximately $4.8 million in cash, subject to certain post-closing adjustments.


ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY NOTE CONCERNING 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.

23



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 that utilize the Tyler private cloud such as e-filing, which simplifies the filing and management of court related documents. We also provide property appraisal outsourcing services for taxing jurisdictions.
Our products generally automate seven 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, (6) records and documents, and (7) data and insights. 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; records and documents; and data and insights. 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.
Our total employee count increased to 4,447 at September 30, 2018, from 4,039 at September 30, 2017.

For the three and nine months ended September 30, 2018, total revenues increased 10% and 11%, respectively, compared to the prior year periods.  Organic revenue growth was 7% and 9% for the three and nine months ended September 30, 2018, respectively compared to the prior year periods and revenues from acquisitions completed as of September 30, 2018 contributed 3% and 2% of growth for the three and nine months ended September 30, 2018, respectively.
Subscriptions revenue grew 32% and 29% for the three and nine months ended September 30, 2018, respectively, due to a gradual shift toward cloud-based, software as a service business, as well as continued strong growth in our e-filing revenues from courts. Organic subscriptions revenue increased 22% and 23% for the three and nine months ended September 30, 2018, respectively.
Our backlog at September 30, 2018 was $1.2 billion, a 7% increase from last year.

Adoption of New Revenue Accounting Standard

On January 1, 2018, we adopted ASU No. 2014-09, using the full retrospective method of transition, which requires that the new standard be applied to all periods presented. The impacts of adoption are reflected in the financial information herein. For additional details, see Note 2 to our condensed consolidated financial statements in this report.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements. These condensed consolidated financial statements have been prepared following the requirements of accounting principles generally accepted in the United States (“GAAP”) for the interim period and require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition and amortization and potential impairment of intangible assets and goodwill and share-based compensation expense. As these are condensed financial statements, one should also read expanded information about our critical accounting policies and estimates provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in our Form 10-K for the year ended December 31, 2017. Except for the accounting policies for revenue recognition, trade and other receivables, and deferred commissions that were updated as a result of adopting ASU No. 2014-09, there have been no material changes to our critical accounting policies and estimates from the information provided in our Form 10-K for the year ended December 31, 2017.




24



ANALYSIS OF RESULTS OF OPERATIONS
 
 
Percent of Total Revenues
 
 
Third Quarter
 
Nine Months Ended
 
 
2018
 
2017
 
2018
 
2017
 
 
 
 
As Adjusted
 
 
 
As Adjusted
Revenues:
 
 
 
 
 
 
 
 
Software licenses and royalties
 
9.5
 %
 
10.6
%
 
9.8
 %
 
10.2
 %
Subscriptions
 
24.9

 
20.7

 
23.2

 
20.0

Software services
 
20.4

 
21.4

 
20.9

 
21.6

Maintenance
 
40.8

 
42.8

 
41.2

 
42.9

Appraisal services
 
2.3

 
2.9

 
2.4

 
3.1

Hardware and other
 
2.1

 
1.6

 
2.5

 
2.2

Total revenues
 
100.0

 
100.0

 
100.0

 
100.0

Cost of revenues:
 
 

 
 

 
 
 
 
Software licenses, royalties and acquired software
 
2.9

 
2.9

 
2.9

 
3.0

Software services, maintenance and subscriptions
 
47.2

 
45.7

 
47.2

 
46.2

Appraisal services
 
1.5

 
1.9

 
1.6

 
2.0

Hardware and other
 
1.1

 
1.1

 
1.7

 
1.7

Selling, general and administrative expenses
 
22.3

 
20.7

 
22.0

 
20.9

Research and development expense
 
7.2

 
5.5

 
6.6

 
5.7

Amortization of customer and trade name intangibles
 
1.9

 
1.6

 
1.7

 
1.6

Operating income
 
15.9

 
20.6

 
16.3

 
18.9

Other income (expense), net
 
0.4

 

 
0.3

 
(0.2
)
Income before income taxes
 
16.3

 
20.6

 
16.6

 
18.7

Income (benefit) tax provision
 
(0.1
)
 
2.6

 

 
2.4

Net income
 
16.4
 %
 
18.0
%
 
16.6
 %
 
16.3
 %

Revenues
On April 30, 2018, we acquired all of the capital stock of Socrata, Inc. ("Socrata"), a company that provides open data and data-as-a-service solutions for state and local government agencies including cloud-based data integration, visualization, analysis, and reporting solutions. The following table details revenue for Socrata for the periods presented as of September 30, 2018, which is included in our condensed consolidated statements of income:
 
 
Third Quarter
 
Nine Months Ended
Revenues:
 
 
 
 
  Software licenses and royalties
 
$

 
$

  Subscriptions
 
4,733

 
7,209

  Software services
 
644

 
1,183

  Maintenance
 

 

  Appraisal services
 

 

  Hardware and other
 
20

 
20

        Total revenues
 
$
5,397

 
$
8,412



25



On August 31, 2018, we acquired CaseloadPRO, L.P. ("CaseloadPRO"), a company that provides a fully featured probation case management system. On April 30, 2018, we also acquired Sage Data Security, LLC ("Sage"), a cybersecurity company offering a suite of services that supports an entire cybersecurity lifecycle. The impact of these acquisitions on our operating results is not considered material, individually and in the aggregate, and is not included in the table above. The results of these acquisitions are included with the operating results of the ES segment from their dates of acquisition.
Software licenses and royalties
The following table sets forth a comparison of our software licenses and royalties revenue for the periods presented as of September 30:
 
 
Third Quarter
 
Change
 
Nine Months Ended
 
Change
($ in thousands)
 
2018
 
2017
 
$
 
%
 
2018
 
2017
 
$
 
%
 
 
 
 
As Adjusted
 
 
 
 
 
 
 
As Adjusted
 
 
 
 
ES
 
$
19,544

 
$
21,143

 
$
(1,599
)
 
(8
)%
 
$
60,224

 
$
58,805

 
$
1,419

 
2
%
A&T
 
2,900

 
1,619

 
1,281

 
79

 
7,396

 
5,021

 
2,375

 
47