filings.toolsItem 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
88K characters. Original on sec.gov · Markdown
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
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 primarily utilize 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 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) land and vital records management 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; 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.
Our total employee count increased to 4,525 at December 31, 2018, from 4,069 at December 31, 2017.
For the twelve months ended December 31, 2018, total revenues increased 11% compared to the prior year. Organic revenue growth was 9% for the twelve months ended December 31, 2018, compared to the prior year period and revenues from acquisitions contributed 2% of growth for the twelve months ended December 31, 2018.
Subscriptions revenue grew 28% for the twelve months ended December 31, 2018, 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 and the addition of new subscription revenues from the acquisition of Socrata. Organic subscriptions revenue increased 21% for the twelve months ended December 31, 2018.
Our backlog at December 31, 2018 was $1.25 billion, a 2% increase from last year.
Recent Acquisitions
On December 7, 2018, we acquired certain assets and intellectual property of SceneDoc, Inc. ("SceneDoc"), a company that provides mobile-first, software-as-a-service (SaaS) field reporting for law enforcement agencies. The total purchase price was approximately $6.2 million, of which $5.4 million was paid in cash and approximately $759,000 accrued for a working capital holdback. As of December 31, 2018, the purchase price allocation for SceneDoc is 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.
On October 1, 2018, we acquired all of the equity interests of TradeMaster, Inc. dba MobileEyes ("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 $5.3 million in cash.
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 of $9.3 million was paid in cash.
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 federal, state and local government agencies. The purchase price, net of cash acquired of $1.7 million, was $147.6 million in cash.
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.
As of December 31, 2018, the purchase price allocations for Sage, Socrata, CaseloadPro, and MobileEyes are complete.
The operating results of all 2018 acquisitions 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 totaled approximately $13.9 million and the net loss was $11.5 million for the twelve months ended December 31, 2018. The impact of the Sage, CaseloadPRO, MobileEyes and SceneDoc acquisitions, individually and in the aggregate, on our operating results, assets and liabilities is not material.
Our balance sheet as of December 31, 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.
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 65% of our revenue in 2018. 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 2018, 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, 2018, our total employee count increased to 4,525 from 4,069 at December 31, 2017.
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.
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 1 - "Summary of Significant Accounting Policies" to our consolidated financial statements in this report.
Recent Accounting Guidance not yet Adopted
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:
| • | 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. |
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. Upon adoption, entities will be required to use a modified retrospective approach with an option to use certain practical expedients. We expect to adopt ASU 2016-02 when effective, using the transition method that allows us to initially apply the guidance at the adoption date of January 1, 2019, and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. We expect to use the package of practical expedients that allows us to not reassess: (1) lease classification for any expired or existing leases and (2) initial direct costs for any expired or existing leases. We expect ASU 2016-02 will impact our consolidated financial statements and related disclosures. We are currently evaluating the extent of the impact and expect that most of our lease commitments will be subject to the updated guidance and recognized as lease liabilities and right-of-use assets on our consolidated balance sheets upon adoption. Based on our current portfolio of leases, we estimate a range of $15.5 million to $17.8 million of lease assets and liabilities to be recognized on our balance sheet, primarily relating to office facilities.
Outlook
The local government software market continues to be active, and our backlog at December 31, 2018 reached $1.25 billion, a 2% 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 progress toward completion methods of revenue recognition, estimated standalone selling price ("SSP") for distinct performance obligations, 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 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 highly interdependent or highly interrelated to the product’s functionality. 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 highly interdependent or highly interrelated 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. 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.
Subscription-based services consist of revenues derived from SaaS arrangements, which primarily 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. 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.
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. Revenue is recognized net of allowances for sales adjustments and any taxes collected from customers, which are subsequently remitted to governmental authorities.
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.
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 that 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 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 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 2018, did not result in an impairment charge. During 2018, 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 incentive plan that provides for the grant of stock options, restricted stock units and performance stock units to key employees, directors and non-employee consultants. We estimate the fair value of share-based awards on the date of grant. 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, 2018, 2017 and 2016.
| Percentage of Total Revenues Years Ended December 31, | ||||||||
| 2018 | 2017 | 2016 | ||||||
| As Adjusted | As Adjusted | |||||||
| Revenues: | ||||||||
| Software licenses and royalties | 10.0 | % | 10.3 | % | 11.0 | % | ||
| Subscriptions | 23.6 | 20.5 | 18.8 | |||||
| Software services | 20.5 | 21.5 | 22.6 | |||||
| Maintenance | 41.1 | 42.6 | 42.2 | |||||
| Appraisal services | 2.3 | 3.0 | 3.5 | |||||
| Hardware and other | 2.5 | 2.1 | 1.9 | |||||
| Total revenues | 100.0 | 100.0 | 100.0 | |||||
| Operating expenses: | ||||||||
| Cost of software licenses, royalties and acquired software | 2.9 | 3.0 | 3.3 | |||||
| Cost of software services, maintenance and subscriptions | 46.9 | 46.1 | 45.8 | |||||
| Cost of appraisal services | 1.5 | 1.9 | 2.2 | |||||
| Cost of hardware and other | 1.7 | 1.5 | 1.3 | |||||
| Selling, general and administrative expenses | 22.2 | 20.9 | 21.7 | |||||
| Research and development expense | 6.8 | 5.6 | 5.7 | |||||
| Amortization of customer and trade name intangibles | 1.7 | 1.6 | 1.7 | |||||
| Operating income | 16.3 | 19.4 | 18.3 | |||||
| Other income (expense), net | 0.4 | 0.1 | (0.3 | ) | ||||
| Income before income taxes | 16.7 | 19.5 | 18.0 | |||||
| Income tax (benefit) provision | 0.9 | (0.7 | ) | 2.9 | ||||
| Net income | 15.8 | % | 20.2 | % | 15.1 | % |
2018 Compared to 2017
Revenues
On April 30, 2018, we acquired Socrata, a company that provides open data and data-as-a-service solutions for federal, 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 December 31, 2018, which is included in our consolidated statements of income:
| 2018 | ||||
| Revenues: | ||||
| Software licenses and royalties | $ | — | ||
| Subscriptions | 12,106 | |||
| Software services | 1,751 | |||
| Maintenance | — | |||
| Appraisal services | — | |||
| Hardware and other | 20 | |||
| Total revenues | $ | 13,877 |
On December 7, 2018, we acquired SceneDoc, Inc., a company that provides mobile-first, software-as-a-service (SaaS) field reporting for law enforcement agencies. On October 1, 2018, we acquired MobileEyes, a company that develops software to improve public safety by supporting fire prevention and suppression, emergency response, and structural safety. On August 31, 2018, we acquired CaseloadPRO, a company that provides a fully featured probation case management system. On April 30, 2018, we also acquired 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. 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) | 2018 | 2017 | $ | % | |||||||||||
| As Adjusted | |||||||||||||||
| ES | $ | 83,735 | $ | 78,388 | $ | 5,347 | 7 | % | |||||||
| A&T | 9,706 | 7,854 | 1,852 | 24 | |||||||||||
| Total software licenses and royalties revenue | $ | 93,441 | $ | 86,242 | $ | 7,199 | 8 | % |
Software license and royalties revenue grew 8% compared to the prior year. The majority of this growth was due to an active marketplace as the result of generally positive 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. An increase in the number of larger contracts related to our planning, regulatory and maintenance solutions and public safety solutions also contributed to the growth in license revenue.
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 2018 was approximately 47% selecting perpetual software license arrangements and approximately 53% selecting subscription-based arrangements compared to a client mix in 2017 of approximately 53% selecting perpetual software license arrangements and approximately 47% selecting subscription-based arrangements.
Subscriptions.
The following table sets forth a comparison of our subscriptions revenue for the years ended December 31:
| Change | |||||||||||||||
| ($ in thousands) | 2018 | 2017 | $ | % | |||||||||||
| As Adjusted | |||||||||||||||
| ES | $ | 210,740 | $ | 164,317 | $ | 46,423 | 28 | % | |||||||
| A&T | 9,807 | 7,859 | 1,948 | 25 | |||||||||||
| Total subscriptions revenue | $ | 220,547 | $ | 172,176 | $ | 48,371 | 28 | % |
Subscription-based revenue primarily consists of revenue derived from our SaaS arrangements, which generally 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 the results of acquisitions, subscription-based revenue increased 21% compared to 2017. New SaaS clients as well as existing clients who converted to our SaaS model provided the majority of the subscription revenue increase. In 2018, we added 410 new SaaS clients and 97 existing clients elected to convert to our SaaS model. Also, e-filing services contributed approximately $6.2 million of the subscription revenue increase in 2018. The increase in e-filing revenue is attributed to new e-filing clients, as well as increased volumes as the result of several existing clients mandating e-filing. The acquisition of Socrata, which primarily has a subscription revenue model, also contributed to the increase in subscription revenues.
Software services.
The following table sets forth a comparison of our software services revenue for the years ended December 31:
| Change | |||||||||||||||
| ($ in thousands) | 2018 | 2017 | $ | % | |||||||||||
| As Adjusted | |||||||||||||||
| ES | $ | 166,921 | $ | 161,245 | $ | 5,676 | 4 | % | |||||||
| A&T | 24,348 | 19,215 | 5,133 | 27 | |||||||||||
| Total software services revenue | $ | 191,269 | $ | 180,460 | $ | 10,809 | 6 | % |
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 3% compared to the prior year period. This growth is due to a higher level of new software sales, through both our license and subscription models.
Maintenance.
The following table sets forth a comparison of our maintenance revenue for the years ended December 31:
| Change | |||||||||||||||
| ($ in thousands) | 2018 | 2017 | $ | % | |||||||||||
| As Adjusted | |||||||||||||||
| ES | $ | 359,904 | $ | 337,701 | $ | 22,203 | 7 | % | |||||||
| A&T | 24,617 | 21,618 | 2,999 | 14 | |||||||||||
| Total maintenance revenue | $ | 384,521 | $ | 359,319 | $ | 25,202 | 7 | % |
We provide maintenance and support services for our software products and certain third-party software. Maintenance revenue grew 7% 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) | 2018 | 2017 | $ | % | |||||||||||
| As Adjusted | |||||||||||||||
| ES | $ | — | $ | — | $ | — | — | % | |||||||
| A&T | 21,846 | 25,023 | (3,177 | ) | (13 | ) | |||||||||
| Total appraisal services revenue | $ | 21,846 | $ | 25,023 | $ | (3,177 | ) | (13 | )% |
In 2018, appraisal services revenue decreased 13% 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) | 2018 | 2017 | $ | % | |||||||||||
| As Adjusted | |||||||||||||||
| Software licenses and royalties | $ | 3,802 | $ | 3,321 | $ | 481 | 14 | % | |||||||
| Acquired software | 22,972 | 21,686 | 1,286 | 6 | |||||||||||
| Software services, maintenance and subscriptions | 438,923 | 387,634 | 51,289 | 13 | |||||||||||
| Appraisal services | 14,299 | 16,286 | (1,987 | ) | (12 | ) | |||||||||
| Hardware and other | 15,708 | 12,595 | 3,113 | 25 | |||||||||||
| Total cost of revenues | $ | 495,704 | $ | 441,522 | $ | 54,182 | 12 | % |
The following table sets forth a comparison of gross margin percentage by revenue type for the years ended December 31:
| Gross margin percentage | 2018 | 2017 | Change | ||||||
| As Adjusted | |||||||||
| Software licenses, royalties and acquired software | 71.3 | % | 71.0 | % | 0.3 | % | |||
| Software services, maintenance and subscriptions | 44.9 | 45.6 | (0.7 | ) | |||||
| Appraisal services | 34.5 | 34.9 | (0.4 | ) | |||||
| Hardware and other | 33.6 | 28.8 | 4.8 | ||||||
| Overall gross margin | 47.0 | % | 47.5 | % | (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 0.3% is due to higher software license revenues offset by an increase in amortization expense for acquired software attributed to new acquisitions completed in 2018.
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 2018, the software services, maintenance and subscriptions gross margin decreased 0.7% compared to the prior year. Excluding employees added through acquisitions, our implementation and support staff has grown by 57 employees since December 31, 2017 as we accelerated hiring to ensure that we are well-positioned to deliver our current backlog and anticipated new business. Recognition of acquisition-related deferred revenue associated with subscriptions and maintenance also resulted in lower gross margins.
Appraisal services. Appraisal services revenue comprised approximately 2.3% of total revenue. The appraisal services gross margin decreased 0.4% compared to 2017 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 2018 blended gross margin slightly decreased by 0.5% compared to 2017. Our overall gross margin decrease is mainly attributed to additions to our implementation staff and lower margin revenues from appraisal services, offset by improved margin on revenues from software licenses.
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) | 2018 | 2017 | $ | % | |||||||||||
| As Adjusted | |||||||||||||||
| Selling, general and administrative expenses | $ | 207,605 | $ | 175,914 | $ | 31,691 | 18 | % |
SG&A as a percentage of revenue was 22.2% in 2018 compared to 20.9% in 2017. SG&A expense increased approximately 18% compared to the prior year period. In 2018, our operating results include $9.1 million of SG&A expenses for Socrata from the date of acquisition. The remaining SG&A expense increase is mainly due to compensation cost related to increased staff levels, higher stock compensation expense and increased commission expense as a result of higher sales. Excluding employees added with acquisitions, we have added 47 employees mainly to our sales and finance teams since December 31, 2017. In addition, our 2018 stock compensation expense rose $11.2 million, mainly due to increases in our stock price over the last few years.
Research and Development Expense
Research and development expense consists primarily of salaries, employee benefits and related overhead costs associated with new product development. The following table sets forth a comparison of our research and development expense for the years ended December 31:
| Change | |||||||||||||||
| ($ in thousands) | 2018 | 2017 | $ | % | |||||||||||
| Research and development expense | $ | 63,264 | $ | 47,324 | $ | 15,940 | 34 | % |
Research and development expense increased 34% in 2018 compared to the prior year period, mainly due to a number of new Tyler product development initiatives across our product suites, including increased investments in research and development at recently acquired businesses. To support these initiatives, our research and development staff has grown by 159 since December 31, 2017.
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) | 2018 | 2017 | $ | % | |||||||||||
| As Adjusted | |||||||||||||||
| Amortization of customer and trade name intangibles | $ | 16,217 | $ | 13,381 | $ | 2,836 | 21 | % |
Amortization of customer and trade name intangibles increased due to the impact of intangibles added with several acquisitions completed in 2017 and 2018.
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):
| 2019 | $ | 16,459 | |
| 2020 | 15,350 | ||
| 2021 | 15,232 | ||
| 2022 | 14,740 | ||
| 2023 | 14,665 | ||
| Thereafter | 95,419 |
Amortization expense relating to acquired leases will be recorded as a reduction to hardware and other revenue and is expected to be $372,000 in 2019, $313,000 in 2020, $312,000 in 2021, $312,000 in 2022, $312,000 in 2023 and $723,000 thereafter.
Other
The following table sets forth a comparison of other income (expense), net for the years ended December 31:
| Change | ||||||||||||||
| ($ in thousands) | 2018 | 2017 | $ | % | ||||||||||
| Other income, net | $ | 3,378 | $ | 698 | $ | 2,680 | N/M |
Other 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. Other income, net, increased compared to the prior period due to increased interest income from significantly higher levels of cash and investments resulting from cash generated in the last year. We had no debt in the current period, as we repaid all borrowings under the revolving line of credit in January 2017.
Income Tax Provision (Benefit)
The following table sets forth a comparison of our income tax provision for the years ended December 31:
| Change | |||||||||||||||
| ($ in thousands) | 2018 | 2017 | $ | % | |||||||||||
| As Adjusted | |||||||||||||||
| Income tax provision (benefit) | $ | 8,408 | $ | (6,115 | ) | $ | 14,523 | (237 | )% | ||||||
| Effective income tax rate | 5.4 | % | (3.7 | )% |
The increase in the income tax provision in 2018 is primarily due to the one-time tax benefit of $26.0 million (as adjusted) recognized in the fourth quarter of 2017 resulting from the remeasurement of deferred tax assets and liabilities associated with the enactment of the Tax Act which reduced the statutory U.S. federal corporate income tax rate from 35% to 21%. The increase is somewhat offset by the decrease in statutory U.S. federal corporate income tax rate for 2018. In addition, excess tax benefits from stock option exercises were lower in 2018 as compared to the prior period. Stock option exercise activity in 2018 generated excess tax benefits of $32.5 million, while stock option exercise activity in 2017 generated $40.6 million excess tax benefits.
The increase in the effective income tax rate in 2018 compared to 2017 is also primarily attributable to the one-time tax benefit associated with the Tax Act recognized in 2017 and the decrease in excess tax benefits related to stock option exercises realized, offset by the decrease in statutory U.S. federal corporate income tax rate for 2018. Excluding the impact of the Tax Act and the excess tax benefits, our income tax provision and effective tax rate in 2018 would have been $42.6 million and 27.4% and in 2017, would have been $60.5 million (as adjusted) and 37.0%, respectively.
The effective income tax rates in both 2018 and 2017 differed from the statutory United States federal corporate income tax rate of 21% and 35%, respectively, due to state income taxes, the research tax credit, non-deductible share-based compensation expense, disqualifying incentive stock option dispositions, and other non-deductible business expenses, and in 2017, the domestic production activities deduction.
2017 Compared to 2016
Revenues
Software licenses and royalties.
The following table sets forth a comparison of our software licenses and royalties revenue for the years ended December 31:
| Change | |||||||||||||||
| ($ in thousands) | 2017 | 2016 | $ | % | |||||||||||
| As Adjusted | As Adjusted | ||||||||||||||
| ES | $ | 78,388 | $ | 78,271 | $ | 117 | — | % | |||||||
| A&T | 7,854 | 5,462 | 2,392 | 44 | |||||||||||
| Total software licenses and royalties revenue | $ | 86,242 | $ | 83,733 | $ | 2,509 | 3 | % |
Software license and royalties revenue increased 3% compared to the prior year. The increase in software licenses and royalties is attributed to additions to our implementation staff, which increased our capacity to deliver backlog.
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:
| Change | |||||||||||||||
| ($ in thousands) | 2017 | 2016 | $ | % | |||||||||||
| As Adjusted | As Adjusted | ||||||||||||||
| ES | $ | 164,317 | $ | 135,469 | $ | 28,848 | 21 | % | |||||||
| A&T | 7,859 | 7,188 | 671 | 9 | |||||||||||
| Total subscriptions revenue | $ | 172,176 | $ | 142,657 | $ | 29,519 | 21 | % |
Subscription-based revenue primarily consists of revenue derived from our SaaS arrangements, which generally 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 21% 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 size 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 | $ | % | |||||||||||
| As Adjusted | As Adjusted | ||||||||||||||
| ES | $ | 161,245 | $ | 155,322 | $ | 5,923 | 4 | % | |||||||
| A&T | 19,215 | 16,326 | 2,889 | 18 | |||||||||||
| Total software services revenue | $ | 180,460 | $ | 171,648 | $ | 8,812 | 5 | % |
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 5% 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 | $ | % | |||||||||||
| As Adjusted | As Adjusted | ||||||||||||||
| ES | $ | 337,701 | $ | 302,409 | $ | 35,292 | 12 | % | |||||||
| A&T | 21,618 | 18,589 | 3,029 | 16 | |||||||||||
| Total maintenance revenue | $ | 359,319 | $ | 320,998 | $ | 38,321 | 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 | ) | N/M | ||||||||||
| 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 | ||||||
| As Adjusted | As Adjusted | ||||||||
| Software licenses, royalties and acquired software | 71.0 | % | 69.9 | % | 1.1 | % | |||
| Software services, maintenance and subscriptions | 45.6 | 45.1 | 0.5 | ||||||
| Appraisal services | 34.9 | 37.6 | (2.7 | ) | |||||
| Hardware and other | 28.8 | 30.3 | (1.5 | ) | |||||
| Overall gross margin | 47.5 | % | 47.3 | % | 0.2 | % |
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 1.1% 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 0.5% compared to the prior year. Our implementation and support staff grew by 220 employees in 2017. 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 slightly increased 0.2% 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
The following table sets forth a comparison of selling, general and administrative expenses for the years ended December 31:
| Change | |||||||||||||||
| ($ in thousands) | 2017 | 2016 | $ | % | |||||||||||
| As Adjusted | As Adjusted | ||||||||||||||
| Selling, general and administrative expenses | $ | 175,914 | $ | 165,176 | $ | 10,738 | 7 | % |
SG&A as a percentage of revenue was 20.9% in 2017 compared to 21.7% in 2016. SG&A expense increased approximately 7% mainly due to compensation costs related to increased staff levels, merit increases and higher stock compensation expense. We added 28 SG&A employees, mainly to our sales and finance teams in 2017. In addition, our 2017 stock compensation expense rose $4.7 million, mainly due to increases in our stock price over the last few years.
Research and Development Expense
The following table sets forth a comparison of our research and development expense for the years ended December 31:
| Change | |||||||||||||||
| ($ 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 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
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 | $ | % | |||||||||||
| As Adjusted | As Adjusted | ||||||||||||||
| Amortization of customer and trade name intangibles | $ | 13,381 | $ | 13,202 | $ | 179 | 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.
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 increased 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 | $ | % | |||||||||||
| As Adjusted | As Adjusted | ||||||||||||||
| Income tax provision | $ | (6,115 | ) | $ | 21,957 | $ | (28,072 | ) | (128 | )% | |||||
| Effective income tax rate | (3.7 | )% | 16.2 | % |
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 $26.0 million (as adjusted) 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 $60.5 million (as adjusted) and 37.0%, respectively. Excluding the excess tax benefits, our income tax provision and effective tax rate in 2016 would have been $51.5 million (as adjusted) and 38.0% 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 other non-deductible business expenses.
FINANCIAL CONDITION AND LIQUIDITY
As of December 31, 2018, we had cash and cash equivalents of $134.3 million compared to $185.9 million at December 31, 2017. We also had $97.7 million invested in investment grade corporate bonds, municipal bonds and asset-backed securities as of December 31, 2018 compared to $63.8 million at December 31, 2017. These investments mature between 2018 through 2022 and we intend to hold these investments until maturity. Cash and cash equivalents consist of cash on deposit with several domestic banks and money market funds. As of December 31, 2018, we had no outstanding borrowings and no outstanding letters of credit. We believe our revolving line of credit, cash from operating activities, cash on hand and access to the credit markets provide us with sufficient flexibility to meet our long-term financial needs.
The following table sets forth a summary of cash flows for the years ended December 31:
| ($ in thousands) | 2018 | 2017 | 2016 | |||||||||
| Cash flows provided (used) by: | ||||||||||||
| Operating activities | $ | 250,203 | $ | 195,755 | $ | 191,859 | ||||||
| Investing activities | (238,255 | ) | (85,395 | ) | (50,720 | ) | ||||||
| Financing activities | (63,595 | ) | 39,415 | (138,075 | ) | |||||||
| Net (decrease) increase in cash and cash equivalents | $ | (51,647 | ) | $ | 149,775 | $ | 3,064 |
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 2018, operating activities provided cash of $250.2 million compared to $195.8 million in 2017. Operating activities that provided cash were primarily comprised of net income of $147.5 million, non-cash depreciation and amortization charges of $61.8 million and non-cash share-based compensation expense of $52.7 million. Working capital, excluding cash, increased approximately $14.0 million due to higher accounts receivable because of an increase in unbilled receivables attributed to revenues recognized from prior billings, higher accounts receivable related to annual maintenance and subscription billings, 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 income tax payments.
In general, changes in the balance of deferred revenue are cyclical and primarily driven by the timing of our maintenance and subscription billings. Our renewal dates occur throughout the year, but our largest maintenance renewal cycles occur in the second and fourth quarters.
Days sales outstanding in accounts receivable were 111 days at December 31, 2018, compared to 102 days at December 31, 2017. The increase in our DSO is mainly due to an increase in unbilled receivables attributed to the increase in software license 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. An increase in software services contracts accounted for using progress-to-completion method of revenue recognition in which the services are performed in one accounting period, but the billing normally occurs subsequently in another accounting period also contributed to the increase in DSO. Furthermore, our maintenance billing cycle typically peaks at its highest level in June and second highest level in December of each year and is followed by collections in the subsequent quarter. 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 $238.3 million in 2018 compared to $85.4 million in 2017. We invested $115.6 million and received $81.2 million in proceeds from investment grade corporate bonds, municipal bonds and asset-backed securities with maturity dates ranging from 2018 through 2022. Approximately $27.4 million was invested in property and equipment, primarily for computer equipment, furniture and fixtures in support of internal growth, particularly with respect to our cloud-based offerings. We paid $2.2 million for the expansion of existing buildings. On December 7, 2018, we acquired certain assets and intellectual property of SceneDoc, Inc., a company that provides mobile-first, SaaS field reporting for law enforcement agencies. The total purchase price was approximately $6.2 million, of which $5.4 million was paid in cash and approximately $759,000 accrued for a working capital holdback. On October 1, 2018, we acquired all of the equity interests of 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 $5.3 million in cash. On August 31, 2018, we acquired all of the assets of CaseloadPRO, a company that provides a fully featured probation case management system. The purchase price of $9.3 million was paid in cash. On April 30, 2018, we acquired all of the capital stock of 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. On April 30, 2018, we acquired all of the equity interests of 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. These expenditures were funded from cash generated from operations.
In 2017, we invested $59.8 million and received $28.8 million in proceeds from investment grade corporate bonds, municipal bonds and asset-backed securities. 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.
Financing activities used cash of $63.6 million in 2018 compared to cash provided of $39.4 million in 2017. Financing activities in 2018 were comprised of collections of $83.0 million from stock option exercises and employee stock purchase plan activity. We also purchased approximately 781,000 shares of our common stock for an aggregate purchase price of $150.1 million, of which $3.5 million was accrued as of December 31, 2018.
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.
In February 2019, 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 2019. As of February 20, 2019, we had remaining authorization to repurchase up to 2.7 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, 2018, our interest rate was 5.75% under the prime rate option or approximately 3.77% 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, 2018, we were in compliance with those covenants.
As of December 31, 2018, we had no outstanding borrowings and had unused borrowing capacity of $300.0 million under the Credit Facility. We paid interest of $770,000 in 2018, $804,000 in 2017, and $1.9 million in 2016.
We paid income taxes, net of refunds received, of $6.8 million in 2018, $36.0 million in 2017, and $30.2 million in 2016. In 2018, we experienced significant stock option exercise activity that generated net tax benefits of $32.5 million and reduced tax payments accordingly. In 2017 and 2016, excess tax benefits were $40.6 million and $29.6 million, respectively.
We anticipate that 2019 capital spending will be between $54 million and $56 million, including approximately $16 million related to real estate and approximately $6 million of capitalized software development. We expect the majority of the other capital spending will consist of computer equipment and software for infrastructure replacements and expansion. Capital spending is expected to be funded from existing cash balances and cash flows from operations.
On January 31, 2019, we entered in to a Merger agreement to acquire 100% of the equity interests of MP Holdings, Parent, Inc. dba MicroPact ("MicroPact") for the anticipated purchase price of $185 million in cash at closing (subject to possible adjustments and holdback) plus contingent consideration not to exceed $10 million. The completion of the acquisition is subject to customary closing conditions, including the expiration or the termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act. The Federal Trade Commission granted early termination of that waiting period effective February 15, 2019. The cash portion of the merger consideration will be funded from cash on hand and proceeds from the revolving credit facility.
On February 1, 2019, we acquired all the assets of Civic, LLC ("MyCivic"), a company that provides software solutions to connect communities. The purchase price is $3.7 million of which $3.6 million was paid in cash and approximately $90,000 was accrued for a working capital holdback.
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 and other equipment used in our operations under non-cancelable operating lease agreements expiring at various dates through 2026.
Summarized in the table below are our obligations to make future payments under the Credit Facility and lease obligations at December 31, 2018 (in thousands):
| 2019 | 2020 | 2021 | 2022 | 2023 | Thereafter | Total | |||||||||||||||||||||
| Revolving line of credit | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | |||||||||||||
| Lease obligations | 5,994 | 5,146 | 3,976 | 1,925 | 1,164 | 2,132 | 20,337 | ||||||||||||||||||||
| Total future payment obligations | $ | 5,994 | $ | 5,146 | $ | 3,976 | $ | 1,925 | $ | 1,164 | $ | 2,132 | $ | 20,337 |
As of December 31, 2018, 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, 2018, our capitalization consisted of no outstanding borrowings and $1.3 billion of shareholders’ equity.
Previous: Item 6. SELECTED FINANCIAL DATA. · Next: Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.