Tyler Technologies
Annual Report 2001

Plain-text annual report

T h e F u t u r e I s H e r e . 2 0 0 1 A n n u a l R e p o r t I n 1997,we charted a new course for the future of Tyler Technologies. It was a future that seemed far away then, with many challenges standing between what we were and what we wanted to be—a premier provider of end-to- end, integrated solutions and information technology services for the local government marketplace. That future is here. We have achieved what we set out to do. We have built a company that has the people,the products and the resources to serve the wide- ranging technology needs of local governments nationwide. We have improved our financial position, strengthened our balance sheet and repaid our acquisition debt. And we have achieved profitability. Increasingly, local governments are recognizing the need to make their services more accessible and more responsive to the public. That is where their future lies…and that future is here, in the innovative, single-source products and services we can provide for all their information technology needs. We now have the infrastructure in place to build a great company. The future is here—in the experience and resourcefulness of our people. In the loyalty and long-standing trust of our customers. In the quality and breadth of our products and services. And in the vast opportunity of our marketplace. L E T T E R T O S H A R E H O L D E R S The year 2001 was a pivotal year for Tyler Technologies. It was a year Our revenue growth is the result of gains in each of our three major of accomplishment, as we worked to reach critical goals that we had revenue categories during 2001. Software license revenues set for ourselves. In the midst of a difficult economic environment, we increased in every quarter. Revenue from professional services grew met or exceeded those goals and completed our transition into a by more than 41 percent. Growth in recurring revenues was position of strength. The future we have planned and worked strong, with a 23 percent increase in maintenance and support toward is here. Our goals were ambitious. On the heels of a year characterized by post-Y2K industry slowdowns and disappointing results, we targeted revenue growth of more than 20 percent in 2001. We aimed for quarter-by-quarter improvement in our EBITDA. We wanted to generate free cash flow for the year. And we said that we would attain profitability. These were high expectations from where we stood a year ago. We are pleased to report that we not only met these specific goals, but also strengthened the company in many ways during 2001. • Revenues increased 26 percent to $117.9 million for the year—all from internal growth. • We achieved profitability. Ending the year with three consecutive profitable quarters, we reported pretax income from continuing operations of $1.8 million for 2001, compared with a pretax loss of $10.3 million in 2000. • EBITDA increased with each quarter in 2001. EBITDA totaled $13.0 million for the year, or 27 cents per share, more than triple the EBITDA of $4.3 million, or 9 cents per share recorded in 2000. • We generated free cash flow after capital expenditures. • SG&A expense was reduced from 35 percent of revenues in 2000 to 26 percent of our 2001 revenues. • Tyler repaid all its bank debt in 2001. Recently we entered into an agreement for a new $10 million bank revolving credit facility for working capital needs, although we do not anticipate borrowing against this credit line. We have a comfortable cash position and expect our cash flow from operations to be significantly greater than our planned capital expenditures. revenues compared to 2000. At the end of 2001, our backlog of signed contracts and deferred revenue balance—both indicators of future revenues—remained strong. The total backlog of signed contracts was $96.3 million at year-end, and we expect nearly 80 percent of that to be realized as revenue within 2002. John M. Yeaman Louis A. Waters 2 The result is a stronger company, an improved balance sheet and a Our performance in 2001 demonstrates that our plan is working and growing cash position that paves the way for a promising future. that our company has the ability to execute its strategies. The That brings us to one of the most important accomplishments of 2001. We believe that in the year 2001 we achieved a level of critical mass in our business that will make our future growth increasingly profitable. Over the past few years, we have successfully aligned our infrastructure to provide the kind of leverage that generates increasing profitability. We have assembled a complement of business units that represent the leading providers of products and services for a broad range of IT applications for local government, addressing customer needs in the areas of financials, justice and courts, property tax and appraisal, and recording systems. The company has a large and growing customer base, with nearly 6,000 local government installations across successful achievement of our goals can be attributed to several key factors. One is the ever-increasing demand for technology in the local government market, creating a robust and ready market for the expertise we offer. Tyler is meeting that market squarely, with the most extensive offering of products and services in the industry. We also have an exceptionally loyal base of customers who give us high marks for our products and services and work with us to build long-lasting relationships. Most significantly, we have a hard-working team of 1,200 employees whose expertise in the information technology industry is matched in full measure by their drive and dedication to building a great company. the U.S., Canada and Puerto Rico. In place are the administrative and Most certainly, the future we have envisioned is here at Tyler support systems, coupled with the staff and management, to serve an Technologies. We appreciate the confidence of our shareholders, expanding customer base. At the heart of the company is the financial customers and employees as we work together to make it a future foundation to fund continuing capital expenditure and development of continuing achievement and increasing value. goals, with a nearly debt-free balance sheet and sustained cash flow prospects. Put simply, we have reached the point of critical mass—in our financial position, our customer base, our products and services and our operating infrastructure—where the rate of future revenue growth can significantly outstrip the corresponding increase in our basic costs and expenses. As we grow, adding new customers and migrating existing customers to new technology, we believe this new operating and financial leverage will have a tremendous impact on the bottom line. Building on this foundation, we are looking forward to continued improvement in our results in 2002. We anticipate solid revenue growth that reflects our strong market position and our ability to continue to gain market share. Because of the tremendous leverage in our business model, we expect that future growth will be increasingly profitable, with EBITDA and earnings per share growing at a substantially greater rate than revenues. Louis A. Waters Chairman John M.Yeaman President 3 G R O W I N G N E E D S , G R O W I N G O P P O R T U N I T Y. Tyler Technologies has a vast and receptive convenience of the Internet for many day-to-day Against the backdrop of this large and growing marketplace for its products and services. activities, they want local governments to offer market is a varied array of service providers. As a leading provider of information them the ability to obtain information, conduct There are numerous small companies which technology (IT) solutions and services for local transactions and even pay utility bills, fines and compete in regional or niche markets, and governments, the company answers the need taxes online. for advanced technology in virtually every area of operation for cities, counties, schools and other local government entities. In addition to providing better service to constituents, local governments see internal needs for improved information technology. The state, local and municipal government Local governments are responsible for a wide market is one of the largest and most range of public services, from property taxes, decentralized markets for information technology public safety and utilities to courts, criminal in the United States. In addition to the 50 justice and welfare services—each area generating states, it includes approximately 3,200 counties huge numbers of transactions, records and and more than 40,000 cities, towns and other data. Improving the speed and efficiency of local government agencies with specialized processing these translates into improved functions. According to industry estimates, revenue collection, faster access to information, these government agencies are expected to and streamlined delivery of services. It also there are large companies which serve the local government market as only one of many different markets. Tyler Technologies stands out as the largest company solely focused on providing software and IT services to the local government market. It has the broadest product line in the industry, a strong national presence and a large, loyal customer base. With a long-standing reputation for quality products and customer service,Tyler’s business units have provided software and services to local governments for an average of well over 20 years. spend $44.4 billion on IT products and services means that information can be shared between This is a large market with growing needs. It in 2002, growing to $56.4 billion by 2005. different agencies and government offices, is a market with tremendous opportunity for There are a number of reasons for the strong and steady growth in this market. Local shortening the time frame for obtaining data a company that can provide the products or documents from days to minutes. and services, the technological support, the customer service, the long-term commitment to working relationships, and continuing advances in information technology solutions that local governments need. Tyler Technologies is uniquely positioned to do just that. governments are experiencing pressure from Faced with budget constraints and increasing all sides for more advanced information workloads, local governments are depending on management systems. A technology-savvy technology to streamline and automate processes public increasingly demands better service and to provide Internet access. Utilizing a from local governments, including improved provider of high quality IT products and services access to information as well as interactive not only results in improved productivity capability. Accustomed to the speed and and cost savings, but also reduces the need to compete with the private sector in attracting and retaining highly skilled IT personnel. All these factors come together to make the investment in information technology a cost- efficient solution with a solid return. “Going from manual document re c o rding to an automated system was a huge undertaking for our department. Tyler made it a smooth and very successful transition, backing up a great product with exceptional customer service and training. With the new system, we were able to re c o rd m o re than 300 additional documents per day, reduce the staff needed to support the operations and cut the time required for document processing from months to days. As a result, we can p rovide better service to the business and financial community, and that is good for our city.” Joan T. Decker Commissioner of Records City of Philadelphia, Pennsylvania 4 M A R K E T The future is here in a large and growing market comprised of local government entities in 50 states, approximately 3,200 counties and more than 40,000 municipalities and other local government agencies. Responding to the demand for improved service and better access to information, these local governments look to companies like Tyler to provide the solutions and services that will streamline and automate their operations while improving productivity and reducing costs. M E E T I N G T H E M A R K E T. With the broadest product line in the industry, Providing products and services to virtually Property Appraisal and Tax. Bringing effective Tyler Technologies is the premier provider of every area of local government,Tyler’s extensive information management to the appraisal and state-of-the-art information management solutions offerings are grouped into four major areas. assessment administration of real and personal to local governments nationwide. Over the years, its business units have earned a reputation for bringing greater efficiency, productivity and cost-effectiveness to the counties, cities, schools and other local government agencies they serve. Financial and City Solutions. As municipalities look for ways to enhance financial, payroll and administration operations with Web-enabled technology solutions,Tyler provides the answers with modular fund accounting systems tailored to meet the needs of cities, counties, school Tyler’s expertise at providing end-to-end districts, public utilities and not-for-profit solutions is rooted in a thorough understanding organizations of any size. Focused on automating of the critical back-office functions of local all aspects of financial management, Tyler’s governments. This knowledge, coupled with systems include modules for general ledger, its singular focus on the local government budget preparation, fixed assets, purchasing, market, enables Tyler to deliver exceptional accounts payable, investment management, proper ty, Tyler provides software and professional appraisal services to help local governments nationwide fairly administer their major source of revenues—property taxes. Its tax collection systems are fully integrated with appraisal and assessment applications for seamless management of all processes. In addition,Tyler Technologies is the nation’s largest provider of real property appraisal outsourcing services for taxing jurisdictions, performing physical inspection, data collection and processing, computer analysis and arbitration services. expertise through a core of application tax collection, payroll and human resources. Recording. To help county governments software that meets the market with precision and focus. The company’s comprehensive and flexible suite of professional services includes software and hardware installation, network design, management, installation, data conversion, training and support. Most of its customers purchase software solutions for use in-house, while others retain Tyler to maintain hardware and software on-site. Tyler also offers outsourced hosting of applications and data at its own data center. Additionally, the company is the leading provider of real property appraisal outsourcing services, which contributes substantially to its revenue base. In every instance, Tyler provides ongoing customer service and technological support to ensure optimum product performance. Justice and Courts. Timely access to information and data is essential in today’s justice and law enforcement processes. Tyler offers a complete, integrated suite of products that automate, track and manage the law enforcement and judicial processes from beginning to end. In law enforcement, it offers systems that automate police and sheriff functions, from computer-aided dispatch/emergency 911 call management and records management through booking and jail management. For efficient court administration, it offers Web-enabled systems to manage all information involved in criminal and civil court cases. These fully integrated systems allow Internet access to a wide range of information, including criminal and civil court records, jail booking and release information. streamline document recording and access, Tyler offers specialized applications to record and index information for public records. Its advanced indexing and retrieval software systems provide accurate recording of documents such as deeds, mortgages, liens, UCC financing statements and vital records, and also utilize the Internet to provide electronic recording and public access to records filed with the county. In 2001, Tyler introduced a revolutionary unified court case management system that merg e s case management, calendaring, document imaging and financial management into a single package. The new product, called Odyssey, marks the beginning of a new generation of national Tyler-branded solutions that will leverage a common framework of n-tier, bro w s e r - b a s e d technology. Many of Odyssey’s design concepts are unique to the court automation marketplace, and initial response to the product has been overwhelmingly positive. Odyssey Court Case Management System 6 P R O D U C T S The future is here in the industry’s broadest line of information technology products for local governments, with solutions and services that span nearly every aspect of local government operations. Innovation and excellence are the hallmarks of Tyler’s product line, as it works to provide customers with technology that makes government processes more efficient, accessible and cost-effective. K N O W L E D G E A N D E X P E R I E N C E M A K E T H E D I F F E R E N C E . Tyler Technologies is a company known for shared vision for operating as a unified company technology, but it is first and foremost a company with common goals for performance and built on people. Serving the technology needs of local government requires far more than offering the right products in the right markets. In this marketplace, success hinges on a company’s ability to build and nurture customer relationships, achievement. The management and directors of Tyler collectively own more than 10 million shares of the company’s common stock, excluding options and warrants, giving them an additional shared stake in growing the company and increasing shareholder value. to understand customer needs and to provide A strong financial foundation, a loyal customer the best technological solutions to those needs. base, a competitive contingent of products Tyler has brought together a cadre of people and services—all these are vital to a company’s with just those capabilities: people who possess success. But the true measure of Tyler’s deep domain expertise in the operations of strength can be found in the quality of the local government, are highly skilled in information people who work day in and day out to technology, and are committed to making the contribute to the continuing growth and technology work for the customer. The strength performance of the company. of its people permeates the entire organization, and is evident in the present management of Tyler’s business units, where the entrepreneurs who originally built the operating units are still managing those businesses. Bringing together people of this caliber has given Tyler exceptional strength throughout its ranks of 1,200 people. At the helm is a strong corporate management team with successful experience in large and high-growth companies. Across all business units, there are people with decades of experience in specific technology solutions for local government. And there is a “We have worked with Tyler since 1990, purchasing its software after a prior experience with poor service, support and maintenance from another company. We learned at that time h o w important support services are in relation to an overall software p roduct. We c h o s e Tyler not only because it has excellent products, but also because it has a staff and a system devoted to software support. Over the years, they have been very responsive to our needs.” Bill Herzog, CPA County Auditor Hays County, Texas 8 P E O P L E The future is here in the 1,200 employees of Tyler Technologies who possess an exceptional level of deep domain expertise and technological experience. Tyler’s business units are managed by the entrepreneurs who built them into successful enterprises, bringing a legacy of strength to the management team. B U I L D I N G R E L A T I O N S H I P S T H A T L A S T. It’s a fact of business: Customers have a choice. established which keep Tyler in tune with the They choose one product over another, one changing needs of its customers. Over the company over another, based on the value course of time,Tyler’s customers often migrate they receive for their investment. Tyler to new and improved products or make Technologies respects that choice and works modifications that bring added functionality hard to merit the confidence of its 6,000 to existing systems. This, too, translates into customers by consistently delivering the highest added value for the customer. quality products and services. Because of its extensive product line,Tyler offers It is a philosophy that has served Tyler customers a distinct advantage by serving as Technologies well. Doing business for an a single-source provider for multiple solutions. average of more than 20 years, Tyler’s As the largest provider of technology solutions major operating units have maintained an to local governments, the company offers focused annual customer retention rate of over solutions for virtually every area of operations, 99 percent. There are good reasons for that remarkable customer retention rate. Tyler provides its customers with real-world solutions that help make the business of running local government more efficient and effective. With products and services that are second to none,Tyler offers from justice and law enforcement to tax and appraisal, records and financial administration. This contributes to long-term relationships as customers come to depend on Tyler for continual improvement, technological updates and innovative solutions that span all aspects of local government. customers the assurance of quality and There is no substitute for business relationships performance across a wide range of applications. that are founded on proven trust and It also offers a singular focus on the local mutual benefit. When needs are met, government market, putting all its time and promises are kept and exceptional value resources into understanding the way local is realized, customers stay. For those reasons, government operates and developing solutions they stay with Tyler Technologies. that work. That’s value to the customer. Tyler earns the trust of its customers by providing superior ongoing support and service, long after the installation is complete. As a result, close working relationships are “In the 12 years that we’ve used Tyler’s MUNIS® system, we have found the financial and payroll solutions to be outstanding at meeting our needs. We also find that working with a single p rovider for multiple applications offers many advantages. We know we can pick up the phone and call anyone from the technician to top management, any time. They are always there , with ideas, input and solutions that address our issues and demonstrate a true understanding of how we operate and what we need.” Ruth Lewis Comptroller Town of Arlington, Massachusetts 10 C U S T O M E R S The future is here in Tyler’s long-standing and loyal customer base. Tyler delivers exceptional value and quality to the 6,000 local government offices it serves nationwide, ensuring that customers are well-served and needs are met. The result is long-lasting customer relationships. Over an average of more than 20 years,Tyler’s major business units have maintained an annual customer retention rate of more than 99 percent. Tyler’s mission has always been to make flow and solid prospects for increasing government more accessible to the public, profitability in the years ahead. It has a large, more responsive to the needs of citizens growing base of longtime customers, providing and more efficient through the migration to the potential to generate high volume in an integrated technology environment. That recurring and additional revenues for the remains the goal of the company, as it continues future. It has deep domain expertise in its to bring products to the marketplace that management and staff, which will drive its generate increased productivity and budget continuing success as a company focused on savings for local governments. being the premier provider of information Never has the company been in a better technology solutions for local government. position to capitalize on the opportunities of The past few years have been a time of building the future. The marketplace for its products for Tyler Technologies. The coming years will and services is large and growing, as local be a time of growth, as the company leverages governments increasingly turn to technology its new position of financial and operational to help them manage present and future needs. strength to drive increasingly greater profitability Tyler has a solid national presence, serving from future revenues. 6,000 customers in 49 states, Canada and Puerto Rico. It has the most extensive line of IT products and services for local government in the industry, and a strategy to continually bring new, evolving solutions to the market. It has a strong financial foundation, with a nearly debt-free balance sheet, excellent cash The future is here at Tyler Technologies. And it is a future filled with opportunity. T H E F U T U R E I S H E R E 12 This page does not print. It is for placement only. F I N A N C I A L I N F O R M A T I O N Consolidated Statements of Operations 14 Report of Ernst & Young LLP, Independent Auditors 32 Selected Financial Data 33 Management’s Discussion and Analysis of Financial Condition and Results of Operations 34 Consolidated Statements of Operations For the years ended December 31 In thousands, except per share amounts 2001 2000 1999 Revenues: Software licenses Professional services Maintenance Hardware and other Total revenues Cost of revenues: Software licenses Professional services and maintenance Hardware and other Total cost of revenues Gross margin Selling, general and administrative expense Costs (recovery) of certain acquisition opportunities Amortization of acquisition intangibles Operating income (loss) Interest expense Interest income Income (loss) from continuing operations before income taxes Income tax provision (benefit) Income (loss) from continuing operations Discontinued operations: Income (loss) from operations, after income taxes Loss on disposal, after income taxes Loss from discontinued operations Net income (loss) Basic and diluted income (loss) per common share: Continuing operations Discontinued operations Net income (loss) per common share Basic weighted average common shares outstanding Diluted weighted average common shares outstanding See accompanying notes. $ 18,899 52,858 39,915 6,216 $ 18,615 37,412 32,537 4,636 $ 20,252 21,679 19,721 9,764 117,888 93,200 71,416 3,982 69,272 4,615 77,869 2,172 53,193 3,560 58,925 2,515 27,159 7,353 37,027 40,019 34,275 34,389 31,065 (235) 6,898 32,805 — 6,903 27,553 1,851 4,966 2,291 (5,433) 19 (630) 151 (4,914) 30 (2,096) 299 1,812 1,540 272 (10,317) (2,810) (7,507) — (3) (3) (4,251) (12,839) (17,090) (1,778) 188 (1,966) 1,902 (2,760) (858) 269 $ (24,597) $ (2,824) 0.01 (0.00) 0.01 $ $ (0.17) (0.37) (0.54) $ $ (0.05) (0.02) (0.07) 47,181 47,984 45,380 45,380 39,105 39,105 $ $ $ 14 Tyler Technologies, Inc. Consolidated Balance Sheets December 31 In thousands, except share and per share amounts 2001 2000 ASSETS Current assets: Cash and cash equivalents Accounts receivable (less allowance for losses of $1,275 in 2001 and $1,505 in 2000) Income tax receivable Prepaid expenses and other current assets Deferred income taxes Total current assets Net assets of discontinued operations Property and equipment, net Other assets: Investment security available - for - sale Goodwill and other intangibles, net Sundry LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities: Accounts payable Accrued liabilities Current portion of long-term obligations Net current liabilities of discontinued operations Deferred revenue Total current liabilities Long-term obligations, less current portion Deferred income taxes 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 and 48,042,969 shares issued in 2001 and 2000, respectively Additional paid-in capital Accumulated deficit Accumulated other comprehensive loss Treasury stock, at cost; 920,205 and 863,522 shares in 2001and 2000, respectively Total shareholders’ equity See accompanying notes. Tyler Technologies, Inc. 15 $ 5,271 35,256 356 3,318 1,329 45,530 1,000 6,967 11,238 82,211 234 $ 8,217 36,599 323 2,465 1,469 49,073 5,095 6,175 5,092 84,700 577 $ 147,180 $ 150,712 $ 2,036 9,651 123 786 27,215 39,811 2,910 3,575 $ 4,299 11,745 353 5,187 21,066 42,650 7,747 4,193 — — 481 157,242 (48,943) (4,545) (3,351) 480 158,776 (49,212) (10,691) (3,231) 100,884 96,122 $ 147,180 $ 150,712 Consolidated Statements of Shareholders’ Equity For the years ended December 31, 2001, 2000 and 1999 In thousands Balance at December 31, 1998 Comprehensive income: Common Stock Shares Amount Additional Paid-in Capital Accumulated Other Comprehensive Accumulated Income (Loss) Deficit Treasury Stock Shares Amount Total Shareholders’ Equity 35,913 $ 359 $ 103,985 $ — $ (21,791) (1,423) $ (6,207) $ 76,346 Net loss Unrealized gain on investment security — — Total comprehensive income Issuance of treasury shares pursuant to stock compensation plans Investment security available-for-sale Shares issued for acquisitions Revision of federal income tax benefit related to exercise of stock options Balance at December 31, 1999 Comprehensive loss: Net loss Unrealized loss on investment security Total comprehensive loss Issuance of treasury shares pursuant to stock compensation plans Shares issued for private investment Balance at December 31, 2000 Comprehensive income: Net income Unrealized gain on investment security Total comprehensive income Issuance of common stock pursuant to stock compensation plans Federal income tax benefit related to exercise of stock options Shares received from sale of discontinued business Adjustment in connection with previous acquisition — 2,810 5,986 — 44,709 — — — 3,334 48,043 — — 105 — — — — — — 28 60 — 447 — — — 33 480 — — 1 — — — — — (31) 15,754 31,728 (138) — (2,824) 17,931 — — — — — — — — — — — 5 — — — — — 50 — — — (2,824) 17,931 15,107 19 15,782 31,788 (138) 151,298 17,931 (24,615) (1,418) (6,157) 138,904 — (24,597) — — (28,622) — — — — (24,597) (28,622) (53,219) 555 — 2,926 — 1,167 9,270 — — — (1,759) 9,237 — — 158,776 (10,691) (49,212) (863) (3,231) 96,122 — — 221 33 — (1,788) — 6,146 — — — — 269 — — — — — — — 3 — (60) — — — 8 — 269 6,146 6,415 230 33 (128) (128) — (1,788) Balance at December 31, 2001 48,148 $ 481 $ 157,242 $ (4,545) $ (48,943) (920) $ (3,351) $ 100,884 See accompanying notes. 16 Tyler Technologies, Inc. Consolidated Statements of Cash Flows For the years ended December 31 In thousands 2001 2000 1999 Cash flows from operating activities: Net income (loss) Adjustments to reconcile net income (loss) to net cash provided (used) by operations: Depreciation and amortization Non-cash interest charges Impairment of notes receivable Provision for doubtful accounts receivable Deferred income tax provision (benefit) Discontinued operations - noncash charges and changes in operating assets and liabilities Changes in operating assets and liabilities, exclusive of effects of acquired companies and discontinued operations: Accounts receivable Income tax receivable Prepaid expenses and other current assets Other receivables Accounts payable Accrued liabilities Deferred revenue Net cash provided (used) by operating activities Cash flows from investing activities: Additions to property and equipment Software development costs Cost of acquisitions, net of cash acquired Cost of acquisitions subsequently discontinued Capital expenditures of discontinued operations Proceeds from disposal of discontinued operations, net of transaction costs Issuance of notes receivable Other Net cash (used) provided by investing activities Cash flows from financing activities: Net (payments) borrowings on revolving credit facility Payments on notes payable Payment of debt of discontinued operations Issuance of common stock Net sale of common shares to employee benefit plans Debt issuance costs Net cash (used) provided by financing activities Net (decrease) increase in cash and cash equivalents Cash and cash equivalents at beginning of year $ 269 $ (24,597) $ (2,824) 10,910 361 — 1,681 1,258 9,686 2,069 — 1,438 (2,890) 6,111 468 1,851 388 (753) (2,385) 8,215 5,614 (258) (33) (853) — (2,263) (2,092) 6,149 12,744 (3,101) (6,225) (2,750) — (1,353) 3,675 — 48 (9,706) (4,750) (354) (992) — 230 (118) (5,984) (2,946) 8,217 (7,052) 2,571 48 85 697 1,370 1,234 (7,126) (2,645) (6,714) — (3,073) (2,201) 79,821 — 213 65,401 (56,250) (836) (2,925) 9,270 19 (1,300) (52,022) (12,934) (2,673) 629 1,477 (67) 1,304 2,124 715 (2,244) (1,368) (25,087) (862) (9,613) 15,114 (1,335) 652 (24,743) 30,190 (3,916) — — 19 (1,338) 24,955 6,253 1,964 927 1,037 Cash and cash equivalents at end of year $ 5,271 $ 8,217 $ 1,964 See accompanying notes. Tyler Technologies, Inc. 17 Notes to Consolidated Financial Statements December 31, 2001 and 2000 (Tables in thousands, except per share data) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS Tyler Technologies, Inc. (“Tyler” or the “Company”) provides integrated software systems and related services for local governments. Tyler develops and markets a broad line of software products and services to address the information technology (“IT”) needs of cities, counties, schools and other local government entities. Tyler also provides professional IT services to its customers, including software and hardware installation, data conversion, training and product modifications, along with continuing maintenance and support for customers using its systems. The Company also provides property appraisal outsourcing services for taxing jurisdictions. The Company discontinued the operations of its information and property records services segment in 2000. See Note 3 for discussion of discontinued businesses. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. All significant intercompany balances and transactions have been eliminated in consolidation. CASH AND CASH EQUIVALENTS Cash and cash equivalents of $5.3 million and $8.2 million at December 31, 2001 and 2000, respectively, consist of money market investments with an initial term of less than three months. For purposes of the statements of cash flows, the Company considers all investments with original maturities of three months or less to be cash equivalents. REVENUE RECOGNITION The Company derives revenue from software licenses, postcontract customer support/maintenance (“PCS”), and services. PCS includes telephone support, bug fixes, and rights to upgrade on a when-and-if available basis. Services range from installation, training, and basic consulting to software modification and customization to meet specific customer needs. In software arrangements that include rights to multiple software products, specified upgrades, PCS, and/or other services, the Company allocates the total arrangement fee among each deliverable based on the relative fair value of each of the deliverables, determined based on vendor-specific objective evidence. The Company recognizes revenue in accordance with Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended, as follows: Software Licenses - The Company recognizes the revenue allocable to software licenses and specified upgrades upon delivery of the software product or upgrade to the end user, unless the fee is not fixed or determinable or collectibility is not probable. If the fee is not fixed or determinable, revenue is recognized as payments become due from the customer. If collectibility is not considered probable, revenue is recognized when the fee is collected. Arrangements that include software services, such as training or installation, are evaluated to determine whether those services are essential to the functionality of other elements of the arrangement. A majority of the Company’s software arrangements involve “off-the-shelf” software and the other elements are not considered essential to the functionality of the software. For those software arrangements in which services are not considered essential, the software license fee is recognized as revenue after delivery has occurred, customer acceptance is reasonably assured, the fee represents an enforceable claim and is probable of collection and the remaining services such as training are considered nominal. Software Services - When software services are considered essential, revenue under the entire arrangement is recognized as the services are performed using the percentage-of-completion contract accounting method. When software services are not considered essential, the fee allocable to the service element is recognized as revenue as the services are performed. Computer Hardware Equipment - Revenue allocable to equipment based on vendor specific evidence of fair value is recognized when the equipment is delivered and collection is probable. Postcontract Customer Support - PCS agreements are generally entered into in connection with initial license sales and subsequent renewals. Revenue allocated to PCS is recognized on a straight-line basis over the period the PCS is provided. All significant costs and expenses associated with PCS are expensed as incurred. Contract Accounting - For arrangements that include customization or modification of the software, or where software services are otherwise considered essential, or for real estate appraisal projects, revenue is recognized using contract accounting. Revenue from these arrangements is recognized using the percentage-of- completion method with progress-to-completion measures based primarily upon labor hours incurred or units completed. Revenue earned is based on the progress-to-completion percentage after giving effect to the most recent estimates of total cost. Changes to total estimated contract costs, if any, are recognized in the period they are determined. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Deferred revenue consists primarily of payments received in advance of revenue being earned under software licensing, software and hardware installation, support and maintenance contracts. USE OF ESTIMATES The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and 18 Tyler Technologies, Inc. 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. Actual results could differ from those estimates. PROPERTY AND EQUIPMENT Property, equipment and purchased software are recorded at cost. Depreciation and amortization are computed for financial reporting purposes primarily utilizing the straight-line method over the estimated useful lives of the related assets, or for leasehold improvements and capital leases, the shorter of the base lease term or estimated useful life. For income tax purposes, accelerated depreciation methods are primarily used with the establishment of deferred income tax liabilities for the resulting temporary differences. Maintenance and repairs are charged to expense as incurred. Costs of renewals and betterments are capitalized. The cost and accumulated depreciation and amortization applicable to assets sold or otherwise disposed of are removed from the asset accounts, and any net gain or loss is included in the statement of operations. INTEREST COST The Company capitalizes interest cost as a component of capitalized software development costs. During the years ended December 31, 2001 and 2000, the Company capitalized $578,000 and $586,000, respectively, of interest cost. No interest cost was capitalized in 1999. RESEARCH AND DEVELOPMENT COSTS The Company expenses all research and development costs as incurred. The Company expensed $412,000, $973,000 and $1.6 million of research and development costs in 2001, 2000 and 1999, respectively. INCOME TAXES Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. STOCK COMPENSATION As permitted by Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” the Company continues to apply the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” as amended. Under APB Opinion No. 25, compensation expense is recorded on the date of grant only if the current market price of the underlying common stock exceeds the exercise price. COMPREHENSIVE INCOME (LOSS) The following table sets forth the components of total comprehensive income (loss) for the periods presented: Years ended December 31, 2001 2000 1999 Net income (loss) Other comprehensive income (loss): Unrealized gain (loss) on investment securities available-for-sale Total comprehensive income (loss) $ 269 $ (24,597) $ (2,824) 6,146 (28,622) 17,931 $ 6,415 $ (53,219) $ 15,107 There was no tax effect in connection with the change in the unrealized gain (loss) for each of the years presented since management could not conclude it was more likely than not that the tax benefit would be realized on the cumulative unrealized holding loss. SEGMENT AND RELATED INFORMATION Although the Company has a number of operating subsidiaries, separate segment data has not been presented as they meet the criteria for aggregation set forth in SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information.” GOODWILL AND OTHER INTANGIBLE ASSETS The cost of acquired companies is allocated first to identifiable assets based on estimated fair values. Costs allocated to identifiable intangible assets are amortized on a straight-line basis over the remaining estimated useful lives of the assets, as determined principally by underlying contract terms or independent appraisals. The excess of the purchase price over the fair value of identifiable assets acquired, net of liabilities assumed, is recorded as goodwill and amortized on a straight-line basis over the estimated useful life. The useful life is determined based on the individual characteristics of the acquired entity and ranges from twenty to twenty-five years. Tyler Technologies, Inc. 19 Notes to Consolidated Financial Statements (Continued) In June 2001, the Financial Accounting Standards Board (the “FASB”) issued SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 addresses the accounting and reporting of acquired goodwill and other intangibles assets. SFAS No. 142 discontinues amortization of acquired goodwill and instead requires annual impairment testing of acquired goodwill. Intangible assets will be amortized over their useful economic life and tested for impairment in accordance with SFAS No. 142. Intangible assets with an indefinite useful economic life should not be amortized until their life is determined to be finite. The provisions of SFAS No. 142 will be effective for fiscal years beginning after December 31, 2001 and will be adopted effective January 1, 2002. SFAS No. 142 will have a significant impact on the Company’s financial results based on the historical amortization of goodwill (including workforce). During 2001, 2000 and 1999, the Company reported after-tax goodwill amortization expense of approximately $3.0 million, $2.9 million, and $2.2 million, respectively, which, beginning January 1, 2002, will no longer be expensed under SFAS No. 142. The Company does not anticipate the adoption of SFAS No. 142 to generate an impairment charge in 2002. IMPAIRMENT OF LONG-LIVED ASSETS The Company accounts for its long-lived assets in accordance with the provisions of SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.” SFAS No. 121 requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets, including goodwill, to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell. COSTS OF COMPUTER SOFTWARE SFAS No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed,” requires capitalization of software development costs incurred subsequent to establishment of technological feasibility and prior to the availability of the product for general release to customers. In 2001, 2000 and 1999, the Company capitalized approximately $6.2 million, $6.7 million and $1.4 million, respectively, of software development costs, which primarily include personnel costs. Systematic amortization of capitalized costs begins when a product is available for general release to customers and is computed on a product-by-product basis at a rate not less than straight-line basis over the product’s remaining estimated economic life. Amortization of software development costs in 2001, 2000 and 1999 was approximately $1.7 million, $622,000 and $75,000, respectively. FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of each class of financial instruments: Cash and cash equivalents, accounts receivables, trade accounts payables and certain other assets: The carrying amounts approximate fair value because of the short maturity of these instruments. The Company’s available-for-sale investments are carried at fair value based on quoted market prices. Long-term obligations: The carrying amount of long-term obligations approximates fair value either due to the variable nature of their stated interest rates or the stated interest rates approximate market rates. These estimated fair value amounts have been determined using available market information or other appropriate valuation methodologies. The Company has no involvement with derivative financial instruments, including those for speculative or trading purposes. CONCENTRATIONS OF CREDIT RISK AND UNBILLED RECEIVABLES Concentrations of credit risk with respect to receivables are limited due to the wide variety of customers and markets into which the Company’s products and services are provided, as well as their dispersion across many different geographic areas. As a result, as of December 31, 2001, the Company does not consider itself to have any significant concentrations of credit risk. The Company’s property appraisal outsourcing service contracts can range up to three years in duration. In connection with these percentage of completion contracts and for certain software service contracts, the Company may perform the work prior to when the services are billable and/or payable pursuant to the contract. The Company has recorded retentions and unbilled receivables (costs and estimated profit in excess of billings) of approximately $7.5 million and $4.7 million at December 31, 2001 and 2000, respectively, in connection with such contracts. Retentions are included in trade accounts receivable and current assets and amounted to $4.5 million at December 31, 2001, of which $3.1 million is expected to be collected in excess of one year. For the year ended December 31, 2001, the Company had one customer that accounted for approximately 13% of the Company’s total consolidated revenues. For the years ended December 31, 2000 and 1999, the Company did not have a single customer that accounted for greater than 10% of total consolidated revenues. RECLASSIFICATIONS The Company reclassified certain prior year accounts of discontinued operations as of December 31, 2000 to conform to the current year presentation. 20 Tyler Technologies, Inc. 2. ACQUISITIONS Effective March 1, 1999, the Company acquired Eagle Computer Systems, Inc. (“Eagle”). Eagle is a leading supplier of networked computing solutions for county governments. Effective April 1, 1999, the Company completed its acquisition of Micro Arizala Systems, Inc. d/b/a FundBalance, a company which develops and markets fund accounting software and other applications for local governments, not-for-profit organizations and cemeteries. On April 21, 1999, the Company acquired Process Incorporated d/b/a Computer Center Software, which designs and develops integrated financial and land management information systems for counties, cities, schools and not-for-profit organizations. Effective May 1, 1999, the Company acquired Gemini Systems, Inc., which develops and markets software products for municipal governments and utilities. On July 16, 1999, the Company acquired Pacific Data Technologies, Inc., which was included in the information and property records services segment which has been discontinued. On November 4, 1999, the Company acquired selected assets and assumed selected liabilities of Cole Layer Trumble Company (“CLT”) from a privately held company (“Seller”). A portion of the consideration consisted of the issuance of 1.0 million restricted shares of Tyler common stock and included a price protection on the sale of the stock. The price protection, which expired November 4, 2001, was equal to the difference between the actual sale proceeds of the Tyler common stock and $6.25 on a per share basis, but was limited to $2.75 million. During the year ended December 31, 2001, the Seller submitted to Tyler a claim under the price protection provision which qualified for the maximum amount of the price protection. Contingent consideration of this nature does not change the recorded costs of the acquisition and the claim is first recorded when submitted. Accordingly, the claim submitted during the year of $2.75 million net of the deferred tax benefit of $963,000, has been charged to paid-in capital during the year. The purchase agreement contained a number of post-closing adjustments which resulted in a receivable of approximately $1.4 million due Tyler from the Seller. During the year ended December 31, 2001 and concurrent with the settlement of the price protection provision, Tyler paid the Seller $1.35 million in cash on a net basis and eliminated the aforementioned receivable. The two parties entered into a mutual release agreement to fully settle the price protection and related purchase agreement provisions. On January 3, 2000, the Company acquired Capitol Commerce Reporter, Inc. (“CCR”). CCR was included in the information and property records services segment which has been discontinued. CCR provided public records research, document retrieval, filing and information services. The Company paid cash of $3.0 million; assumed notes with a fair value of $4.0 million; and paid transaction costs of $90,000 in connection with this acquisition. Tyler Technologies, Inc. 21 The Company accounted for all of the aforementioned acquisitions using the purchase method of accounting for business combinations. Under this method of accounting, the aggregate purchase price is allocated to assets acquired and liabilities assumed based on their estimated fair values. Results of operations of the acquired entities are included in the Company’s consolidated financial statements from the respective dates of acquisition. The excess purchase price over the fair value of the net identifiable assets of the acquired companies (goodwill) is amortized using the straight-line method of amortization over their respective estimated useful lives. During the year ended December 31, 1999, the Company paid cash of $25.6 million; issued 6.0 million shares of Tyler common stock with a fair value of $31.8 million and assumed debt of $2.3 million in connection with its 1999 acquisitions. In addition to consideration paid in cash and common stock for the 1999 acquisitions, the Company provided other consideration which totaled approximately $3.2 million and consisted of assignment of certain notes. Cash paid for acquisitions does not reflect cash paid for transaction costs related to the execution of the acquisitions, such as legal, accounting and consulting fees, of approximately $673,000 in 1999 and excludes acquired cash balances of approximately $338,000 in 1999. 3. DISCONTINUED OPERATIONS I n f o rmation and Pro p e r t y R e c o rds Services Segment On September 29, 2000, the Company sold for a cash sale price of $14.4 million certain net assets of Kofile, Inc. and another subsidiary, the Company’s interest in a certain intangible work product, and a building and related building improvements (“Kofile Sale”). Effective December 29, 2000, the Company sold for cash its land records business unit, consisting of Business Resources Corporation (“Resources”), to an affiliate of Affiliated Computer Services, Inc. (“ACS”) (the “Resources Sale”). The Resources Sale was valued at approximately $71.0 million. Concurrent with the Resources Sale, management of the Company with the Board of Directors’ approval adopted a formal plan of disposal for the remaining businesses and assets of the information and property records services segment. This restructuring program was designed to focus the Company’s resources on its software systems and services segment and to reduce debt. The businesses and assets divested or identified for divesture were classified as discontinued operations in the accompanying consolidated financial statements in 2000 and the prior periods’ financial statements were restated to report separately their operations in compliance with APB Opinion No. 30. The net gain on the Kofile Sale and the Resources Sale amounted to approximately $1.5 million (net of an income tax benefit of $2.4 million). Notes to Consolidated Financial Statements (Continued) The Company’s formal plan of disposal provided for the remaining businesses and assets of the information and property records services segment to be disposed of by December 29, 2001. At the time management elected to discontinue the remaining businesses in this segment, its remaining assets included a start-up company engaged in constructing a Web-enabled national repository of public records data, and Capitol Commerce Reporter, Inc. (“CCR”), which provided public records research, principally in Texas. The interdependency of these operations with those of Resources resulted in the Company’s decision to discontinue the development of the repository and other related products and exit the land records business following the Resources Sale. The estimated loss on the disposal of these remaining businesses and assets at December 29, 2000 amounted to $13.6 million (after an income tax benefit of $3.8 million), consisting of an estimated loss on disposal of the businesses of $11.5 million (net of an income tax benefit of $2.7 million) and a provision of $2.1 million (after an income tax benefit of $1.1 million) for anticipated operating losses from the measurement date of December 29, 2000 to the estimated disposal dates. Although the actual proceeds on the subsequent sales of businesses and assets and the related income tax treatment of the various disposals differed from the individual components of each as originally estimated at December 29, 2000, no adjustment to the net loss reserve is considered appropriate at this time. The anticipated operating losses to the disposal dates include the effects of the settlement of certain employment contracts, losses on real property leases, severance costs and similar closing related costs. The provision for anticipated operating costs which was provided in 2000 approximates actual operating costs incurred since the measurement date of December 29, 2000. On May 16, 2001, the Company sold all of the common stock of another business which had previously been designated as a discontinued operation. In connection with the sale, the Company received cash proceeds of $575,000, approximately 60,000 shares of Company common stock, a promissory note of $750,000 payable in 58 monthly installments at an interest rate of 9%, and other contingent consideration. Because the note receivable is highly dependent upon future operations of the buyer, the Company is recording its value as cash is received. On September 21, 2001, the Company sold all of the common stock of CCR which also had been previously designated as a discontinued operation. The sale price of the common stock consisted of $3.1 million in cash and future payments contingent on the retention of certain customers subsequent to the sale. Since the gains or losses on these sales were estimated as of the measurement date of December 29, 2000, no additional adjustments to the estimated loss on the disposals of the discontinued businesses are considered appropriate at this time. The income tax expense or benefit associated with the gains or losses on the respective sales of the businesses in the information and property records services segment and the planned dispositions of the remaining assets and businesses differs from the statutory income tax rate of 35% due to the elimination of deferred taxes related to the basis difference between amounts reported for income taxes and financial reporting purposes and the utilization of available capital loss carryforwards which were fully reserved in the valuation account prior to the respective sales. The condensed components of net assets of discontinued operations of the information and property records services segment and one of the Company’s non-operating subsidiaries included in the consolidated balance sheets as of December 31, 2001 and 2000 are as follows: Restricted cash Accounts receivable Other current assets Deferred taxes Other current liabilities Less reserve for estimated loss on disposition including post balance sheet operating losses and transactions costs Net current liabilities Property and equipment Goodwill and other intangibles Other liabilities Net noncurrent assets 2001 2000 $ 2,310 100 — 2,192 (5,268) $ — 588 369 (898) (1,995) (120) (786) (3,251) (5,187) 1,000 — — 1,000 2,873 4,129 (1,907) 5,095 Net assets (liability) $ 214 $ (92) 22 Tyler Technologies, Inc. The condensed statements of operations relating to the information and property records services segment for the years ended December 31, 2000 and 1999 are presented below: 2000 1999 $ 39,680 44,635 $ 36,914 32,796 (4,955) (704) 4,118 2,216 $ (4,251) $ 1,902 Revenues Costs and expenses (Loss) income before income tax (benefit) provision Income tax (benefit) provision Net (loss) income O t h e r In December 1998, the Company entered into a letter of intent to sell its non-core automotive parts segment. Accordingly, this segment has been accounted for as a discontinued operation in 1998 with prior years’ financial statements restated to report separately their operations in compliance with APB Opinion No. 30. The Company originally estimated the net loss on disposal to be $8.9 million, which was recorded in the fourth quarter of 1998. The estimated loss included anticipated operating losses from the measurement date of December 1998 to the date of disposal and associated transaction costs. On March 26, 1999, the Company sold all of the outstanding common stock of the company comprising the automotive parts segment and received $15.8 million in cash during 1999 prior to transactions costs. In 1999, the Company recorded additional losses of $907,000 (including income taxes of $183,000) to reflect adjusted estimated transaction costs, funded operating losses which were higher than originally estimated, adjustments to amounts previously provided for income taxes in connection with the sale and to write down to estimated net realizable value a post-closing receivable in connection with a dispute with the purchaser. One of the Company’s non-operating subsidiaries is involved in various claims for work-related injuries and physical conditions relating to a formerly owned subsidiary that was sold in 1995. During 2001, 2000 and 1999, the Company recorded net losses, net of related tax effect, of $3,000, $748,000 and $1.9 million, respectively (see Note 17 in Notes to Consolidated Financial Statements). 4. RELATED PARTY TRANSACTIONS On September 29, 2000, the Company sold for cash certain net assets of Kofile and another subsidiary, the Company’s interest in a certain intangible work product, and a building and related building improvements to investment entities beneficially owned by a principal shareholder of the Company, who was also a director at the time. From time to time, the Company charters aircraft from businesses in which either a former director and/or member of management of the Company is an owner or part owner. For the years ended December 31, 2001, 2000 and 1999 the Company incurred rental expense related to such arrangements to a non-corporate officer management member of $83,000, $81,000 and $116,000 respectively. During 1999 through mid-2000, the Company chartered an aircraft from a former director. The Company incurred rental expense related to these charters of $325,000 and $133,000 in 2000 and 1999, respectively. The Company has three office building lease agreements with various shareholders and a non-corporate officer management member of the Company. Total rental expense related to such leases for the years ended December 31, 2001, 2000 and 1999 was $1.1 million, $679,000 and $525,000, respectively. Total future minimum rental under noncancelable related party operating leases as of December 31, 2001, are as follows: 2002 2003 2004 2005 2006 Thereafter $ 1,244 1,215 1,217 1,147 1,160 3,994 Tyler Technologies, Inc. 23 Notes to Consolidated Financial Statements (Continued) 5. PROPERTY AND EQUIPMENT Property and equipment consists of the following at December 31: Useful Lives (years) 2001 2000 Land Transportation equipment Computer equipment and purchased software Furniture and fixtures Building and leasehold improvements Accumulated depreciation and amortization — $ 5 3-7 3-7 3-35 $ 115 390 115 414 7,542 3,515 1,338 12,900 5,428 2,612 1,315 9,884 (5,933) (3,709) Property and equipment, net $ 6,967 $ 6,175 Depreciation expense totaled $2.3 million, $2.0 million and $1.1 million during the years ended December 31, 2001, 2000 and 1999, respectively. 6. INVESTMENT SECURITY AVAILABLE-FOR-SALE Pursuant to an agreement with two major shareholders of H.T.E., Inc. (“HTE”), the Company acquired approximately 32% of HTE’s common stock in two separate transactions in 1999. On August 17, 1999, the Company exchanged 2.3 million shares of its common stock for 4.7 million shares of HTE common stock. This initial investment was recorded at $14.0 million. The second transaction occurred on December 21, 1999, in which the Company exchanged 484,000 shares of its common stock for 969,000 shares of HTE common stock. The additional investment was recorded at $1.8 million. The investment in HTE common stock is classified as a non-current asset since it was made for a continuing business purpose. Florida state corporation law restricts the voting rights of “control shares”, as defined, acquired by a third party in certain types of acquisitions, which restrictions may be removed by a vote of the shareholders. The courts have not interpreted the Florida “control share” statute. HTE has taken the position that, under the Florida statute, all of the shares acquired by the Company constitute “control shares” and therefore do not have voting rights until such time as shareholders of HTE, other than the Company, restore voting rights to those shares. Management of the Company believes that only the shares acquired in excess of 20% of the outstanding shares of HTE constitute “control shares” and therefore believes it has the right to vote all HTE shares it owns up to at least 20% of the outstanding shares of HTE. On November 16, 2000, the shareholders of HTE, other than Tyler, voted to deny the Company its right to vote the “control shares” of HTE. 24 On October 29, 2001, HTE notified the Company that it had attempted a cash redemption of all of the 5.6 million shares of HTE common stock currently owned by the Company at a price of $1.30 per share. Management of the Company believes that the attempted redemption of the Company-owned HTE shares was invalid and takes exception to the manner in which fair value was calculated. Management of HTE contends that its ability to redeem the shares of common stock owned by the Company and the manner of calculation of fair value by HTE is in accordance with Florida state statutes for “control shares.” On October 29, 2001, the Company notified HTE that its purported redemption of the shares owned by the Company was invalid and contrary to Florida law, and in any event, the calculation by HTE of fair value for such shares was incorrect. On October 30, 2001, HTE filed a complaint in a civil court in Seminole County, Florida requesting the court to enter a declaratory judgment declaring that HTE’s purported redemption of all of the Company-owned shares at a redemption price of $1.30 per share was lawful and to effect the redemption and cancel the Company-owned shares. The Company removed the case to the United States District Court, Middle District of Florida, Orlando Division and requested a declaratory judgment from the court declaring, among other things, (a) that HTE’s purported redemption of any or all of the shares held by the Company was illegal under Florida law, (b) in the alternative, that HTE’s right of redemption, if any, under Florida law only applies to the “control shares” owned by the Company (i.e., those shares in excess of 20% of the issued and outstanding shares of common stock of HTE as of the date that the Company acquired such shares), (c) in the alternative, that HTE’s calculation of fair value for the redemption of any or all of the shares owned by the Company was grossly understated, and (d) that the Company maintains the ability to vote up to 20% of the issued and outstanding shares of HTE common stock owned by the Company. Although the Company believes that the attempted stock redemption by HTE is invalid there can be no assurance that the court will rule in favor of the positions asserted by the Company. Under accounting principles generally accepted in the United States, an investment of 20% or more of the voting stock of an investee should lead to a presumption that in absence of evidence to the contrary, an investor has the ability to exercise significant influence over the operating and financial policies of an investee. Management of the Company has concluded that it currently does not have such influence as evidenced by the following key factors: • Inability to resolve the different interpretations regarding the ability to vote the shares; • Inability to obtain additional financial information not otherwise available to other shareholders; and • Inability to obtain certain confirmations and consents from the investee’s independent auditors. Accordingly, the Company accounts for its investment in HTE pursuant to the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Although these shares are held for a continuing business purpose, these Tyler Technologies, Inc. HTE. Under the equity method, the original investment is recorded at cost and is adjusted periodically to recognize the investor’s share of earnings or losses after the respective dates of acquisition. The Company’s investment in HTE would include the unamortized excess of the Company’s investment over its equity in the net assets of HTE. Because of the effects of such a future change, the following information has been provided or derived from publicly filed financial information which has not been independently confirmed to the Company and is considered unaudited. HTE reported net income of $865,000 and net losses of $3.4 million and $14.9 million for the years ended December 31, 2001, 2000 and 1999, respectively. Subsequent to the Company’s initial acquisition of HTE’s shares in August 1999, HTE recorded charges of approximately $7.9 million, net of tax, related to write-offs of software development costs, certain accounts receivables and employee-termination benefits that were recorded by HTE as a result of changes in management and charges for litigation settlements. During 2000, HTE recovered a portion of these costs, which totaled $1.1 million. These costs would be considered pre-acquisition costs by the Company in determining its share of HTE’s loss from the respective dates of acquisition. Had the Company’s investment in HTE been accounted for under the equity method, the Company would have recorded equity in losses of HTE of $548,000, $2.3 million and $1.4 million for the years ended December 31, 2001, 2000 and 1999, respectively. 7. COSTS (RECOVERY) OF CERTAIN ACQUISITION OPPORTUNITIES In March 1999, the Company entered into a merger agreement pursuant to which the Company contemplated the acquisition of all of the outstanding common stock of CPS Systems, Inc. (“CPS”). In connection with that agreement, the Company provided CPS with bridge financing in the form of notes secured by a second lien on substantially all of the assets of CPS, including accounts receivable, inventory, intangibles, equipment and intellectual property. In January 2000, CPS filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code. On March 24, 2000, the bankruptcy court conducted a public auction of the assets of CPS. Accordingly, the aggregate bridge financings and related accrued interest receivable and costs amounting to $1.9 million were expensed in the 1999 consolidated financial statements. In 2001, the Company received cash of approximately $235,000 through CPS bankruptcy proceedings in connection with the notes. The Company anticipates no further recovery of amounts due under its secured notes. securities are classified as “available-for-sale” and are recorded at fair value as determined by quoted market prices as required pursuant to SFAS No. 115. Unrealized holding gains and losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of shareholders’ equity until realized. Realized gains and losses from the sale of available-for-sale securities are determined on a specific identification basis. A decline in the market value of any available-for-sale security below cost that is deemed to be other than temporary, results in a reduction in the carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. Management of Tyler continues to conclude it has both the intent and the ability to hold the investment for a period of time sufficient to allow for the anticipated recovery in fair value. At this time, management of the Company does not believe the decline in the market value is other than temporary. In making this determination, management considered, among other items, the conditions in the local government software industry, the financial condition of the issuer, and recent public statements by the issuer concerning its future prospects. In addition, for a period of time during 2001 and February 2002, the quoted market value price per share of HTE was above Tyler’s average per share cost basis of $2.81 per share. The cost, fair value and gross unrealized holding gains (losses) of the investment securities available-for-sale, based on the quoted market price for HTE common stock (amounts in millions, except per share amounts) are presented below. In accordance with SFAS No. 115, the Company used quoted market price per share in calculating fair value to be used for financial reporting purposes. SFAS No. 115 does not permit the adjustment of quoted market prices in the determination of fair value and, accordingly, the ultimate value the Company could realize because of its significant investment could vary materially from the amount presented. Quoted Market Price Per Share Cost Gross Unrealized Holding Fair Value Gains (Losses) December 31, 2001 December 31, 2000 February 21, 2002 $ 2.00 0.91 4.36 $ 15.8 15.8 15.8 $ 11.2 5.1 24.5 $ (4.6) (10.7) 8.7 If the uncertainty regarding the voting shares is resolved in the Company’s favor, the Company will retroactively adopt the equity method of accounting for this investment. Therefore, the Company’s results of operations and retained earnings for periods beginning with the 1999 acquisition will be retroactively restated to reflect the Company’s investment in HTE for all periods in which it held an investment in the voting stock of Tyler Technologies, Inc. 25 Notes to Consolidated Financial Statements (Continued) 8. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill, other intangible assets and related accumulated amortization consists of the following at December 31: Useful Lives (years) 20-25 20-25 5 3-5 5-10 4 2001 2000 $ 51,063 17,997 12,158 17,369 6,191 163 $ 51,145 17,997 12,158 11,144 6,191 101 104,941 (22,730) 98,736 (14,036) $ 82,211 $ 84,700 Goodwill Customer base Software acquired Software development costs Workforce Non-compete agreements Accumulated amortization Goodwill and other intangibles, net Amortization expense totaled $8.6 million, $7.5 million and $5.0 million for the years ended December 31, 2001, 2000 and 1999, respectively. 9. ACCRUED LIABILITIES Accrued liabilities consists of the following at December 31: 2001 2000 Accrued wages and commissions Other accrued liabilities Total accrued liabilities $ 7,071 2,580 $ 5,564 6,181 $ 9,651 $ 11,745 The aggregate maturities of long-term obligations for each of the years subsequent to December 31, 2001, are as follows: 2002 - $123,000; 2003 - $74,000; 2004 - $36,000; 2005 - $2.8 million; 2006 - $0. Interest paid in 2001, 2000 and 1999 was $814,000, $8.8 million and $4.1 million, respectively. During the year ended December 31, 2001, the Company had a revolving credit agreement with a group of banks (the “Senior Credit Facility”), which initially provided for borrowings up to $15.0 million and had a maturity date of July 1, 2002. After amendments to the Senior Credit Facility in May and September related to the sale of certain assets, the available borrowings were reduced to $7.0 million. Borrowings under the Senior Credit Facility bore interest at the lead bank’s prime rate plus a margin of 3%. The borrowings were limited to 80% of eligible receivables. In December 2001, the Company terminated the Senior Credit Facility. The effective average interest rates for borrowings under the Senior Credit Facility during 2001 and 2000 were 10.3% and 10.2%, respectively. On March 5, 2002, the Company entered into a new revolving credit agreement with a bank (the “2002 Credit Facility”) which has a maturity date of January 1, 2005 and provides for total availability of up to $10.0 million. Borrowings under the 2002 Credit Facility bear interest at either prime rate or at the London Interbank Offered Rate plus a margin of 3% and are limited to 80% of eligible accounts receivable. The 2002 Credit Facility is secured by substantially all of the Company’s personal property, by a pledge of the common stock of the Company’s operating subsidiaries, and is also guaranteed by such subsidiaries. Under the terms of the 2002 Credit Facility, the Company is required to maintain certain financial ratios and other financial conditions and is prohibited from making certain investments, advances, cash dividends or loans. 11. INCOME TAX The income tax provision (benefit) included in continuing operations consists of the following: 10. LONG-TERM OBLIGATIONS Long-term obligations consists of the following at December 31: Years ended December 31, 2001 2000 1999 Revolving senior credit facility 10% promissory notes payable due January 2005 Other Total obligations Less current portion 2001 2000 $ — $ 4,750 2,800 233 3,033 123 2,800 550 8,100 353 Total long-term obligations $ 2,910 $ 7,747 Current: Federal State Deferred Income tax $ — 282 $ — 80 $ 565 376 282 1,258 80 (2,890) 941 (753) provision (benefit) $ 1,540 $ (2,810) $ 188 26 Tyler Technologies, Inc. The income tax provision (benefit) differs from amounts computed by applying the federal statutory tax rate of 35% to income (loss) from continuing operations before income taxes as follows: Years ended December 31, 2001 2000 1999 Income tax expense (benefit) at statutory rate State income tax, net of federal income tax benefit Non-deductible amortization Non-deductible business expenses Other, net Income tax $ 634 $ (3,611) $ (622) 183 635 83 5 52 640 110 (1) 245 559 80 (74) expense (benefit) $ 1,540 $ (2,810) $ 188 Significant components of deferred tax assets and liabilities as of December 31 are as follows: Deferred income tax assets: Net operating loss carryforward Basis difference on investment security Operating expenses not currently deductible Employee benefit plans Minimum tax credits Research tax credits Other Net deferred income tax assets before valuation allowance Less valuation allowance Net deferred income tax assets Deferred income tax liabilities: Tax-benefit transfer lease Property and equipment Intangible assets Other Total deferred income tax liabilities 2001 2000 $ 3,667 $ 4,054 1,591 3,557 967 299 268 78 100 999 391 268 78 100 6,970 (1,690) 9,447 (3,657) 5,280 5,790 — (1,069) (6,442) (15) (713) (1,107) (6,681) (13) (7,526) (8,514) Net deferred income tax liabilities $ (2,246) $ (2,724) At December 31, 2001, the Company had available approximately $10.5 million of net tax operating loss carryforwards for federal Tyler Technologies, Inc. 27 income tax purposes. These carryforwards, which may provide future tax benefits, expire from 2012 through 2021. Based upon the periods in which taxable temporary differences are anticipated to reverse, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, including the net operating loss carryforwards, at December 31, 2001. However, the amount of the deferred tax asset considered realizable could be adjusted in the future if estimates of reversing taxable temporary differences are revised. Although realization is not assured, management believes it is more likely than not that all the deferred tax assets will be realized except for the asset relating to the basis difference on investment security available-for-sale and other minor temporary differences. Accordingly, the Company believes that no valuation allowance is required for the remaining deferred tax assets. During the year ended December 31, 2000, the Company sold Resources, Kofile and certain other businesses (see Note 3). In connection with these respective sales, the Company utilized approximately $45.9 million of available capital loss carryforwards which were fully reserved in the valuation allowance account at December 31, 1999. The Company paid income taxes, net of refunds received, of $273,000 in 2001 and $2.8 million in 1999, and received a refund of prior years’ income taxes of $2.7 million in 2000. 12. SHAREHOLDERS’ EQUITY In May 2000, the Company sold 3.3 million shares of common stock and 333,380 warrants pursuant to a private placement agreement with Sanders Morris Harris for approximately $10.0 million in gross cash proceeds, before deducting commissions and offering expenses of approximately $730,000. Each warrant is convertible into one share of common stock at an exercise price of $3.60 per share. The warrants expire in May 2005. The common stock sold in this transaction is not registered and may only be sold pursuant to Rule 144 under the Securities Act of 1933, generally after being held for at least one year. As of December 31, 2001, the Company had an additional warrant outstanding to purchase 2.0 million shares of the Company’s common stock at $2.50 per share that expires in September 2007. The warrant was issued in September 1997 to Richmond Partners, Ltd. for which the Chairman of the Board of the Company is deemed to have beneficial ownership. 13. STOCK OPTION PLAN The Company’s stock option plan provides for the granting of non-qualified and incentive stock options, as defined by the Internal Revenue Code, to key employees and directors of the Company and its subsidiaries of up to 5.5 million shares of the Company’s common stock at prices which represent fair market Notes to Consolidated Financial Statements (Continued) value at dates of grant. All options granted have ten-year terms and generally vest over, and become fully exercisable at the end of, three to eight years of continued employment. The following table summarizes the transactions of the Company’s stock option plan for the three-year period ended December 31, 2001: Number of Shares Weighted- Average Exercise Prices 1,918 $ 6.03 1,583 (78) (5) 3,418 498 (417) (5) 3,494 2,185 (933) (108) 4.87 3.67 4.29 5.55 2.76 6.16 3.88 5.08 1.70 5.18 2.13 4,638 $ 3.54 207 706 1,385 1,504 $ 4.94 5.04 5.20 Options outstanding at December 31, 1998 Granted Forfeited Exercised Options outstanding at December 31, 1999 Granted Forfeited Exercised Options outstanding at December 31, 2000 Granted Forfeited Exercised Options outstanding at December 31, 2001 Reserved for future grants at December 31, 2001 Exercisable options: December 31, 1999 December 31, 2000 December 31, 2001 As allowed by SFAS No. 123, the Company has continued to follow APB Opinion No. 25, “Accounting for Stock Issued to Employees,” which does not recognize compensation expense on the issuance of its stock options because the option terms are fixed and the exercise price equals the market price of the underlying stock on the grant date. As required by SFAS No. 123, the Company has determined the pro forma information as if the Company had accounted for stock options granted since January 1, 1995, under the fair value method of SFAS No. 123. The Black-Scholes option pricing model was used with the following weighted-average assumptions for 2001, 2000 and 1999, respectively: risk-free interest rates of 5.1%, 6.1% and 5.6%; dividend yield of 0%; expected common stock market price volatility factor of .78, .73 and .70; and a weighted-average expected life of the options of seven years. The weighted-average fair value of options granted in 2001, 2000 and 1999 was $1.28, $2.02 and $3.47 per share, respectively. Had compensation expense been recorded based on the fair values of the stock option grants, the Company’s 2001, 2000 and 1999 pro forma net loss would have been $919,000, $26.0 million and $4.6 million, or $0.02, $0.57 and $0.12 per diluted share, respectively. During the year ended December 31, 2000, the Company granted to an employee 50,000 shares of restricted common stock with a fair value of $303,000 at the grant date. The Company recorded annual compensation expense of $151,500 during each of the years ended December 31, 2000 and 1999, based on the service period provided for in the agreement and the vesting period over which the restrictions lapse. The following table summarizes information concerning outstanding and exercisable options at December 31, 2001: Range of Exercise Prices Weighted Average Remaining Contractual Life Number of Outstanding Options Average Price of Outstanding Options Number of Exercisable Options Weighted Average Price of Exercisable Options $ 0.00 - $ 2.19 2.19 - 3.28 3.28 - 4.38 4.38 - 5.47 5.47 - 6.56 6.56 - 7.66 7.66 - 8.75 9.84 - 10.94 9.3 years 9.4 6.8 6.9 7.1 6.2 6.8 6.3 2,163 160 835 593 575 236 6 70 $ 1.64 2.62 3.86 5.24 6.12 7.63 7.75 10.62 28 61 2 573 315 349 142 4 58 $ 1.58 2.75 3.81 5.27 6.13 7.63 7.75 10.70 Tyler Technologies, Inc. 14. EARNINGS (LOSS) PER SHARE 15. LEASES Basic earnings per common share data is computed using the weighted-average number of common shares outstanding for the relevant period. Diluted earnings per common share data is computed using the weighted-average number of common shares outstanding plus common share equivalents represented by stock options and stock warrants, if such stock options and stock warrants have a dilutive effect in the aggregate. The Company leases certain offices, and transportation, computer and other equipment used in its operations under noncancelable operating lease agreements expiring at various dates through 2011. Most leases contain renewal options and some contain purchase options. The leases generally provide that the Company pay taxes, maintenance, insurance and certain other operating expenses. The following table sets forth the computation of basic and diluted earnings (loss) per share: Rent expense was approximately $2.8 million in 2001, $2.1 million in 2000 and $1.1 million in 1999. Years Ended December 31, 2001 2000 1999 Future minimum lease payments under noncancelable leases at December 31, 2001 are as follows: 272 $ (7,507) $ (1,966) Fiscal Year 2002 2003 2004 2005 2006 2007 and thereafter 47,181 45,380 39,105 Total future minimum lease payments Operating Leases $ 3,111 2,614 2,328 1,892 1,617 5,357 $ 16,919 Numerator: Income (loss) from continuing operations for basic and diluted earnings per share $ Denominator: Denominator for basic earnings per share – Weighted-average shares Effect of dilutive securities: Employee stock options Warrants Potentially dilutive common shares Denominator for diluted earnings per share – Adjusted weighted average share 593 210 803 — — — — — — 47,984 45,380 39,105 Basic and diluted earnings (loss) per common share from continuing operations $ 0.01 $ (0.17) $ (0.05) For the years ended December 31, 2001, 2000 and 1999, 2.3 million, 3.5 million and 3.4 million options, respectively, were not included in the computation of diluted earnings per share because the effect would have been antidilutive. Additionally, warrants to purchase 333,380, 2.3 million and 2.0 million shares of the Company’s common stock for 2001, 2000, and 1999, respectively, were not included in the computation of diluted earnings per share because the effect would have been antidilutive. Tyler Technologies, Inc. 29 16. EMPLOYEE BENEFIT PLANS The Company has a retirement savings plan structured under Section 401(k) of the Internal Revenue Code (the “Code”). The plan covers substantially all employees meeting minimum service requirements. Under the plan, employees may elect to reduce their current compensation by up to 15%, subject to certain maximum dollar limitations prescribed by the Code, and have the amount contributed to the plan as salary deferral contributions. The Company contributes up to a maximum of 2% of an employee’s compensation to the plan. The Company made contributions to the plan and charged continuing operations $868,000, $761,000 and $396,000 in 2001, 2000 and 1999, respectively. 17. COMMITMENTS AND CONTINGENCIES One of the Company’s non-operating subsidiaries, Swan Transportation Company (“Swan”), has been and is currently involved in various claims raised by hundreds of former employees of a foundry that was once owned by an affiliate of Swan and the Company for alleged work related injuries and physical conditions resulting from alleged exposure to silica, asbestos, and/or related industrial dusts during their employment at the foundry. The operating assets of the foundry were sold by the Company on December 1, 1995. As a non-operating subsidiary of the Company, the current assets of Notes to Consolidated Financial Statements (Continued) Swan consist primarily of various insurance policies issued to Swan during the relevant time periods and restricted cash of $2.3 million at December 31, 2001. Swan has tendered the defense and indemnity obligations arising from these claims to its insurance carriers, who have entered into settlement agreements with approximately 275 of the plaintiffs, each of whom agreed to release Swan, the Company, and its subsidiaries and affiliates from all such claims in exchange for payments made by the insurance carriers. On December 20, 2001, Swan filed a petition under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware. The bankruptcy filing by Swan was the result of extensive negotiations between the Company, Swan, their respective insurance carriers, and an ad hoc committee of plaintiff attorneys representing substantially all of the then known plaintiffs. Swan filed its plan of reorganization in February 2002. The principal features of the plan of reorganization include: (a) the creation of a trust, which is to be funded principally by fifteen insurance carriers pursuant to certain settlement agreements executed pre-petition between Swan, the Company, and such carriers; (b) the implementation of a claims resolution procedure pursuant to which all present and future claimants may assert claims against such trust for alleged injuries; (c) the issuance of certain injunctions under the federal bankruptcy laws requiring any such claims to be asserted against the trust and barring such claims from being asserted, either now or in the future, against Swan, the Company, all of its affected affiliates, and the insurers participating in the funding of the trust; and (d) the full and final release of each of Swan, the Company, all of its affected affiliates, and the insurers participating in the funding of the trust from any and all claims associated with the once-owned foundry by all claimants that assert a claim against, and receive compensation from, the trust. In order to receive the foregoing benefits, the Company has agreed, among other things, to make certain cash contributions to the trust, the amount of which is not expected to be in excess of the settlement liability previously recorded by the Company in its consolidated financial statements. The Company anticipates that Swan’s plan of reorganization will be voted on by the creditors of Swan during the second quarter of 2002. Because the material terms of the plan of reorganization have been pre-negotiated between the various affected parties, the Company anticipates that the plan, as currently contemplated, will be approved by Swan’s creditors, at which time it will then be presented to the bankruptcy court for final approval. If the plan of reorganization as currently contemplated is approved, the Company anticipates that all of the liabilities associated with the foundry formerly owned by affiliates of the Company will be eliminated at an amount no greater than the liability reflected in the consolidated financial statements. There can be no assurance that the plan of reorganization as currently contemplated will be approved by the creditors of Swan, and if approved by such creditors, will be approved in such form by the bankruptcy court, if at all. The Company initially provides for estimated claim settlement costs when minimum levels can be reasonably estimated. If the best estimate of claim costs can only be identified within a range and no specific amount within that range can be determined more likely than any other amount within the range, the minimum of the range is accrued. Based on an initial assessment of claims and contingent claims that may result in future litigation, a reserve for the minimum amount of $2.0 million for claim settlements was recorded in 1996. Legal and related professional services costs to defend litigation of this nature have been expensed as incurred. During the years ended December 31, 2001, 2000, and 1999, the Company charged discontinued operations $3,000, $748,000, and $1.9 million, respectively, in connection with settlement, legal and related professional costs, and the remaining liability was approximately $1.9 million at December 31, 2001. Because of the inherent uncertainty discussed above, it is reasonably possible that the amounts recorded as liabilities for Swan related matters could change in the near term by amounts that would be material to the consolidated financial statements. See Note 6 for discussion of litigation in connection with HTE’s attempted cash redemption of all shares of HTE common stock currently owned by the Company. Other than ordinary course, routine litigation incidental to the business of the Company and except as described herein, there are no material legal proceedings pending to which the Company or its subsidiaries are parties or to which any of its properties are subject. 30 Tyler Technologies, Inc. 18. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) The following tables contain selected financial information from unaudited consolidated statements of operations for each quarter of 2001 and 2000. Quarter Ended Dec. 31 Sept. 30 June 30 Mar. 31 Dec. 31 Sept. 30 June 30 Mar. 31 2001 2000 Revenues Gross margin $ 31,204 $ 28,435 $ 30,977 $ 27,272 $ 26,018 $ 23,724 $ 21,661 $ 21,797 11,346 9,920 10,132 8,621 9,335 9,327 7,583 8,030 Income (loss) from continuing operations before income taxes 1,310 Income (loss) from continuing operations 163 614 251 745 372 (857) (514) (1,759) (1,538) (3,741) (3,279) (1,326) (1,206) (2,638) (2,337) Income (loss) from discontinued operations 35 (23) (1) (14) (13,015) (1,352) (1,341) (1,382) Net income (loss) $ 198 $ 228 $ 371 $ (528) $(14,341) $ (2,558) $ (3,979) $ (3,719) Diluted earnings (loss) from continuing operations Diluted earnings (loss) from discontinued operations $ 0.00 $ 0.01 $ 0.01 $ (0.01) $ (0.03) $ (0.02) $ (0.06) $ (0.06) 0.00 (0.01) (0.00) (0.00) (0.28) (0.03) (0.03) (0.03) Net earnings (loss) per diluted share $ 0.00 $ 0.00 $ 0.01 $ (0.01) $ (0.31) $ (0.05) $ (0.09) $ (0.09) Shares used in computing diluted earnings (loss) per share 48,915 48,396 47,425 47,179 46,665 46,654 44,894 43,291 Tyler Technologies, Inc. 31 Report of Ernst & Young LLP, Independent Auditors THE BOARD OF DIRECTORS AND SHAREHOLDERS TYLER TECHNOLOGIES, INC. We have audited the accompanying consolidated balance sheets of Tyler Technologies, Inc. as of December 31, 2001 and 2000, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Tyler Technologies, Inc. at December 31, 2001 and 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Dallas, Texas February 22, 2002, except for the last paragraph in Note 10 as to which the date is March 5, 2002 32 Tyler Technologies, Inc. Selected Financial Data (In thousands, except per share data) FOR THE YEARS ENDED DECEMBER 31, 2001 2000 1999 1998 1997 STATEMENT OF OPERATIONS DATA: (1) Revenues Costs and expenses: Cost of revenues (2) Selling, general and administrative expense (2) Costs (recovery) of certain acquisition opportunities Amortization of acquisition intangibles Interest expense (income), net Income (loss) from continuing operations before income taxes Income tax provision (benefit) Income (loss) from continuing operations Income (loss) from continuing operations per diluted share $ 117,888 $ 93,200 $ 71,416 $ 23,440 $ — 77,869 31,065 (235) 6,898 479 1,812 1,540 58,925 32,805 — 6,903 4,884 (10,317) (2,810) 37,027 27,553 1,851 4,966 1,797 (1,778) 188 13,143 8,534 3,146 1,499 234 (3,116) (652) — 2,959 — — (822) (2,137) (918) $ $ 272 $ (7,507) $ (1,966) $ (2,464) $ (1,219) 0.01 $ (0.17) $ (0.05) $ (0.08) $ (0.06) Weighted average number of diluted shares 47,984 45,380 39,105 32,612 20,498 OTHER DATA: EBITDA (3) $ 12,968 $ 4,253 $ 7,981 $ 2,256 $ (2,843) AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2001 2000 1999 1998 1997 BALANCE SHEET DATA: (1) Total assets Long-term obligations, excluding current portion Shareholders’ equity STATEMENT OF CASH FLOWS DATA: Cash flows from operating activities Cash flows from investing activities Cash flows from financing activities (1) 2001, 2000, 1999 and 1998 include the results of operations of continuing companies formerly comprising the software systems and services segment from the acquired companies’ respective dates of acquisition and excludes the results of operations of the discontinued information and property records services segment, automotive parts segment and the fund-raising segment. Prior years’ selected financial data has been restated to reflect discontinuation of the information and property records services segment in 2000, the automotive parts segment in 1998 and the fund-raising segment in 1997. For years prior to 1998, selling, general and administrative expense includes only amounts relating to the holding company. See Notes 2 and 3 in Notes to Consolidated Financial Statements. (2) Depreciation and amortization included in cost of revenues and selling, general and administrative expense for 2001, 2000, 1999, 1998 and 1997 was $4,014, $2,783, $1,145, $493 and $116, respectively. Tyler Technologies, Inc. 33 $ 147,180 2,910 100,884 $ 150,712 7,747 96,122 $ 243,260 $ 124,328 37,189 76,346 61,530 138,904 $ 39,543 — 31,403 $ 12,744 (9,706) (5,984) $ (7,126) $ 65,401 (52,022) 715 $ (24,743) 24,955 1,758 (36,787) 27,893 $ (5,829) (2,020) 2,515 (3) EBITDA consists of income or loss from continuing operations before interest, costs (recovery) of certain acquisition opportunities, income taxes, depreciation, and amortization. Although EBITDA is not calculated in accordance with accounting principles generally accepted in the United States, the Company believes that EBITDA is widely used as a measure of operating performance. Nevertheless, this measure should not be considered in isolation or as a substitute for operating income, cash flows from operating activities, or any other measure for determining the Company’s operating performance or liquidity that is calculated in accordance with accounting principles generally accepted in the United States. EBITDA does not take into account the Company’s debt service requirements and other commitments and accordingly EBITDA is not necessarily indicative of amounts that may be available for reinvestment in the Company’s business or other discretionary uses. In addition, since all companies do not calculate EBITDA in the same manner, this measure may not be comparable to similarly titled measures reported by other companies. Management’s Discussion and Analysis of Financial Condition and Results of Operations FORWARD-LOOKING STATEMENTS This Annual Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than historical or current facts, including, without limitation, statements about the business, financial condition, business strategy, plans and objectives of management, and prospects of the Company are forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from these expectations. Such risks and uncertainties include, without limitation, the ability of the Company to successfully integrate the operations of acquired companies, technological risks associated with the acceptance of the Company’s products by its customers, development of new products and the enhancement of existing products, changes in the budgets and regulatory environments of the Company’s government customers, the ability to attract and retain qualified personnel, changes in product demand, the availability of products, changes in competition, changes in economic conditions, changes in tax risks and other risks indicated in the Company’s filings with the Securities and Exchange Commission. These risks and uncertainties are beyond the ability of the Company to control, and in many cases, the Company cannot predict the risks and uncertainties that could cause its actual results to differ materially from those indicated by the forward-looking statements. When used in this Annual Report, the words “believes,” “plans,” “estimates,” “expects,” “anticipates,” “intends,” “continue,” “may,” “will,” “should,” “projects,” “forecasts,” “might,” “could” or the negative of such terms and similar expressions as they relate to the Company or its management are intended to identify forward-looking statements. GENERAL On September 29, 2000, the Company sold for cash certain net assets of Kofile, Inc. (“Kofile”) and another subsidiary, the Company’s interest in a certain intangible work product, and a building and related building improvements. Effective December 29, 2000, the Company sold for cash its land records business unit, Business Resources Corporation (“Resources”), including among others, Resources wholly-owned subsidiaries Government Records Services, Inc. and Title Records Corporation, to an affiliate of Affiliated Computer Services, Inc. (“ACS”). Concurrent with the sale to ACS, management of the Company with the Board of Director’s approval adopted a formal plan of disposal for the remaining businesses and assets of the information and property records services segment. This restructuring program was designed to focus the Company’s resources on its software systems and services segment and to substantially reduce debt. In March 1999, the Company sold its automotive parts segment. The business and assets divested or identified for divesture have been classified as discontinued operations in 2001, 2000 and 1999. All prior year financial information included herein has been restated to reflect these dispositions as discontinued operations. Continuing operations in 2001, 2000, and 1999 are comprised of the results of operations of the companies formerly comprising the software systems and services segment. The following is a summary of significant acquisitions consummated in prior years that remain in continuing operations: On February 19, 1998, the Company acquired The Software Group and Interactive Computer Designs, Inc., which provide county, local and municipal governments with software, systems and services to serve their information technology and automation needs. Effective August 1, 1998, the Company completed the purchase of Computer Management Services, which provides integrated information management systems and services to county and municipal governments. Effective March 1, 1999, the Company acquired Eagle Computer Systems, Inc., which supplies networked computing solutions and services for county governments. Effective April 1, 1999, the Company completed its acquisition of Micro Arizala Systems, Inc. d/b/a FundBalance, a company which develops and markets fund accounting software and other applications for state and local governments, not-for-profit organizations and cemeteries. On April 21, 1999, the Company acquired Process Incorporated d/b/a Computer Center Software, which designs and develops integrated financial and land management information systems for counties, cities, schools and not-for-profit organizations. On November 4, 1999, the Company acquired selected assets and assumed selected liabilities of Cole Layer Trumble Company, (“CLT”), a division of a privately held company. CLT provides property appraisal software and services to governments. All of the Company’s acquisitions have been accounted for using the purchase method for business combinations, and the results of operations of the acquired entities are included in the Company’s historical consolidated financial statements from their respective dates of acquisition. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, 34 Tyler Technologies, Inc. and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to investments, intangible assets, bad debts and long-term service contracts, deferred income tax assets, reserve for discontinued operations and contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed 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. The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements. The Company derives revenue from software licenses, hardware, postcontract customer support/maintenance and services which typically range from installation, training and basic consulting to software modification and customization to meet specific customer needs. For multiple element software arrangements which do not entail the performance of services which are considered essential to the functionality of the software, the Company records revenue when the delivered products or performed services result in a legally enforceable claim. The Company maintains allowances for doubtful accounts, sales adjustments and estimated cost of product warranties which are provided at the time the revenue is recognized. Because of the nature of its customers being governmental entities, the Company rarely incurs a loss resulting from the inability of its customers to make required payments. Alternatively, customers may become dissatisfied with the functionality of the software products and/or the quality of the services and request a reduction of the aggregate contract price or similar concession. While the Company engages in extensive product and service quality programs and processes, the Company’s allowances for such contract price reductions may need to be revised in the future. In connection with its customer contracts and the related adequacy of its reserves and measures of progress towards completion, the Company’s project managers are charged with the responsibility to continually review the status of each customer on a specific contract basis. Also, corporate as well as operating company management review on a quarterly basis significant past due account receivables and the related adequacy of the Company’s reserves. For software arrangements that include customization of the software which is considered essential to its functionality and for real estate appraisal outsourcing projects, the Company recognizes revenue and profit as the work progresses using the percentage- of-completion method. This method relies on estimates of total expected contract revenue, billings and collections and expected contract costs. The Company follows this method since reasonably dependable estimates of the revenue and costs applicable to various stages of a contract can be made. At times, the Company performs additional and/or non-contractual services for little to no incremental fee, to satisfy the customer expectations. Tyler Technologies, Inc. 35 Recognized revenues and profit are subject to revisions such as the type just described as the contract progresses to completion. Revisions to future profit estimates are charged to income in the period in which the facts that give rise to the revision first become known. The Company accounts for all of its acquisitions using the purchase method of accounting for business combinations. The cost of acquired companies is allocated to identifiable assets based on estimated fair value, with the excess allocated to goodwill. Accordingly, the Company has a significant balance of acquisition intangible assets, including software, customer base, workforce and goodwill. In addition, the Company capitalizes software development costs incurred subsequent to the establishment of technological feasibility. These intangible assets are amortized over their estimated useful lives and are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of the asset is generally measured by a comparison of the carrying amount of an asset to estimated future net cash flows expected to be generated by the asset. 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 are not achieved. With an original cost basis of $15.8 million, the Company acquired a 32% interest in HTE, a publicly held company in which the Company is unable to exert significant influence. Accordingly, the investment is classified as an available-for-sale security and is recorded at fair value as determined by quoted market prices, which have been reasonably volatile. The Company’s accounting policy is to record an investment impairment charge when it believes an investment has experienced a decline in value other than temporary. To date, the unrealized holding loss in this investment has been excluded from earnings and has been reported in a separate component of shareholders’ equity. During 2001, HTE attempted a cash redemption for all of the shares held by the Company for an aggregate redemption price of $7.3 million, which is materially less than the carrying value recorded at December 31, 2001 and the Company’s original cost basis, and litigation between the two parties has been initiated. Future adverse changes in market conditions affecting HTE, poor operating results, or an adverse court ruling regarding the attempted redemption or a negotiated settlement could result in a reduction in the original cost basis to the then current fair value being charged to operations in the future. The Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event the Company were to determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should the Company determine that it would not be able to Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued) realize all or part of its net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made. The Company has a reserve for discontinued operations which includes, among other things, a reserve for estimated claim settlement costs associated with work related injuries and physical conditions of former employees resulting from alleged injuries from silica, asbestos, and/or related industrial dusts during their employment. In late 2001, a non-operating subsidiary of the Company filed a bankruptcy petition, and this subsidiary was the parent of a company which was the former owner of a cast iron pipe and fittings foundry where the alleged injuries occurred. Because the material terms of the plan of reorganization have been pre-negotiated between the various affected parties, the Company anticipates that the plan, as currently contemplated, will be approved by the subsidiary’s creditors, at which time it will then be presented to the bankruptcy court for final approval. If the plan of reorganization as currently contemplated is approved, the Company anticipates that all of the liabilities associated with the foundry formerly owned by affiliates of the Company will be eliminated at an amount no greater than the liability reflected in the consolidated financial statements. In the event the proposal plan does not materialize, it is reasonably possible that the amounts recorded as liabilities for this matter could change by material amounts. There can be no assurance that the plan of reorganization as currently contemplated will be approved by the creditors and if approved by such creditors, will be approved in such form by the bankruptcy court, if at all. 2001 COMPARED TO 2000 REVENUES Revenues from continuing operations were $117.9 million for the year ended December 31, 2001, a 26% increase from revenues of $93.2 million for the prior year. Software license revenues increased each quarter during 2001 from $3.6 million in the first quarter to $5.8 million in the fourth quarter. For the year ended December 31, 2001, software license revenue was $18.9 million, compared to $18.6 million for the year ended December 31, 2000. The increase was due mainly to sales of third-party software that provided additional functionality to certain of the Company’s proprietary software, sales of proprietary software to new customers and in new geographic areas, primarily the midwestern United States, and sales of upgraded financial and utility software modules to existing customers. The increase was somewhat offset by lower tax and appraisal software sales. Professional services revenues grew 41% to $52.9 million for the year ended December 31, 2001, from $37.4 million for the year ended December 31, 2000. Included in professional services revenues for the year ended December 31, 2001, was appraisal outsourcing services revenue of $34.3 million, compared to $20.8 million in the prior year. The 65% increase for the year in appraisal outsourcing services revenue was primarily due to the Company’s continued progress on its contract with Nassau County, New York Board of Assessors (“Nassau County”). The contract to provide outsourced assessment services for Nassau County, together with tax assessment administration software and training, is valued at a total of approximately $34.0 million. Implementation of the Nassau County contract began in September 2000 and is expected to be completed by the Spring of 2003. For the year ended December 31, 2001, the Company recorded $14.4 million of professional services revenue related to Nassau County. For the year ended December 31, 2001, maintenance revenue increased 23%, to $39.9 million, from $32.5 million for 2000. Higher maintenance revenue was due to an increase in the Company’s base of installed software and systems products and maintenance rate increases for several product lines. Maintenance and support services are provided for the Company’s software and related products. Hardware and other revenues increased $1.6 million for the year ended December 31, 2001 from $4.6 million for the same period of 2000. Approximately $700,000 of the increase relates to the Nassau County contract. Other increases are due to timing of installations of equipment on customer contracts and are dependent on the contract size and on varying customer hardware needs. COST OF REVENUES For the year ended December 31, 2001, cost of revenues was $77.9 million compared to $58.9 million for the year ended December 31, 2000. The increase in cost of revenues was primarily due to the increase in revenues. Gross margin was 34% for the year ended December 31, 2001, compared to 37% for the year ended December 31, 2000. Overall gross margins were lower because the Company’s 2001 revenue mix included more professional services compared to 2000. Historically, gross margins are higher for software licenses than for professional services due to personnel costs associated with professional services. In addition, software license costs increased during 2001 compared to 2000, due to increased amortization of software development costs. The Company released several new products during the second and third quarters of 2001, at which time amortization of the related software development costs commenced. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE Selling, general and administrative expense for the year ended December 31, 2001 was $31.1 million compared to $32.8 million in the prior year. Selling, general and administrative expense as a percentage of revenues declined to 26% in 2001 from 35% in 2000 because such expenses are primarily fixed and therefore did not increase in proportion to the Company’s revenue growth. The decline in selling, general and administrative expense 36 Tyler Technologies, Inc. NET INTEREST EXPENSE Net interest expense was $479,000 for the year ended December 31, 2001 compared to $4.9 million for the year ended December 31, 2000. Interest expense declined due to a significant reduction in bank debt with the proceeds from the disposal of the Company’s former information and property records services segment (see Note 2 in Notes to Consolidated Financial Statements). In addition, in connection with certain internally developed software projects, the Company capitalized $578,000 of interest costs during 2001, compared to $586,000 for 2000. INCOME TAX PROVISION For the year ended December 31, 2001, the Company had income from continuing operations before income taxes of $1.8 million and an income tax provision of $1.5 million, resulting in an effective tax rate of 85%. For 2000, the Company had a loss from continuing operations before income tax benefit of $10.3 million and an income tax benefit of $2.8 million, resulting in an effective benefit rate of 27%. The effective income tax rate for the year ended December 31, 2001 was different from the statutory United States federal income tax rate of 35% primarily due to non-deductible items such as goodwill amortization as compared to the relative amount of pretax earnings or loss. DISCONTINUED OPERATIONS On September 29, 2000, the Company sold for a cash sale price of $14.4 million certain net assets of Kofile, Inc. and another subsidiary, the Company’s interest in a certain intangible work product, and a building and related building improvements. Effective December 29, 2000, the Company sold for cash its land records business unit, Business Resources Corporation, to an affiliate of ACS (the “Resources Sale”). The Resources Sale was valued at approximately $71.0 million. Concurrent with the Resources Sale, management of the Company with the Board of Directors’ approval adopted a formal plan of disposal for the remaining businesses and assets of the information and property records services segment. This restructuring program was designed to focus the Company’s resources on its software systems and services segment and to reduce debt. The business and assets divested or identified for divesture have been classified as discontinued operations in the accompanying consolidated financial statements with prior periods’ financial statements restated to report separately their operations in compliance with Accounting Principles Board (“APB”) Opinion No. 30. was due to a reduction in corporate costs following the sale of the information and property records services segment, lower acquisition-related costs such as legal and travel expenses and lower research and development costs which are expensed. AMORTIZATION OF ACQUISITION AND OTHER INTANGIBLES The Company has accounted for all of its past acquisitions using the purchase method of accounting for business combinations. The excess of the purchase price over the fair value of the net identifiable assets of the acquired companies (“goodwill”) is amortized using the straight-line method of amortization over their respective estimated useful lives. See “Accounting Pronouncements Not Yet Adopted.” At December 31, 2001 and 2000, the Company had $82.2 million and $84.7 million, respectively, of goodwill, post-acquisition software development costs and other intangible assets, net of accumulated amortization. Such intangibles amounted to 56% of total assets at December 31, 2001 and 2000; and 81% and 88% of shareholders’ equity at December 31, 2001 and 2000, respectively. Goodwill excluding accumulated amortization at December 31, 2001 and 2000 was $51.1 million. Amortization expense of acquisition intangibles was $6.9 million in 2001 and 2000. The Company considers a variety of factors in estimating the useful lives and recoverability of goodwill and other intangible assets. Determining the appropriate useful life of goodwill and other intangible assets is a matter of judgment. In making its determination, the Company considered a number of factors, including the following: • position of the acquired enterprise in the market and the extent of barriers to entry for competitors; • age, historical operating performance, and quality of earnings of the acquired enterprise, including the extent of operating history and the presence or lack of stable earnings history; • experience of the acquired enterprise’s management; • the future viability of products and services, including the impact of technological changes and advances and the level of continued investment necessary to maintain the acquired enterprise’s technological position; • estimated future cash flows of the respective assets; • competition; and • industry practice. In addition, the Company periodically retains the services of an outside appraisal firm to assist in determining the initial value assigned to newly acquired identifiable intangible assets and the estimated useful lives. At December 31, 2001 and 2000, management of the Company believes such assets are recoverable and the estimated useful lives are reasonable. Tyler Technologies, Inc. 37 Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued) The Company’s formal plan of disposal provided for the remaining businesses and assets of the information and property records services segment to be disposed of by December 29, 2001. At the time management elected to discontinue the remaining businesses in this segment, its remaining assets included a start-up company engaged in constructing a Web-enabled national repository of public records data, and Capitol Commerce Reporter, Inc. (“CCR”), which provides public records research, principally in Texas. The interdependency of these operations with those of Resources resulted in the Company’s decision to discontinue the development of the repository and other related products and exit the land records business following the Resources Sale. The estimated loss on the disposal of these remaining businesses and assets at December 29, 2000, amounted to $13.6 million (after an income tax benefit of $3.8 million), consisting of an estimated loss on disposal of the businesses of $11.5 million (net of an income tax benefit of $2.7 million) and a provision of $2.1 million (after an income tax benefit of $1.1 million) for anticipated operating losses from the measurement date of December 29, 2000 to the estimated disposal dates. Although the actual proceeds on the subsequent sales of businesses and assets and the related income tax treatment of the various disposals differed from the individual components of each as originally estimated at the time the reserve for losses for discontinued operations was first established, no adjustment to the net loss reserve is considered appropriate at this time. The anticipated operating losses to the disposal dates include the effects of the settlement of certain employment contracts, losses on real property leases, severance costs and similar closing related costs. The provision for anticipated operating costs which was provided in 2000 approximates actual operating costs incurred since the measurement date of December 29, 2000. On May 16, 2001, the Company sold all of the common stock of another business that had previously been designated as a discontinued operation. In connection with the sale, the Company received cash proceeds of $575,000, approximately 60,000 shares of Company common stock, a promissory note of $750,000 payable in 58 monthly installments at an interest rate of 9%, and other contingent consideration. Because the note receivable is highly dependent upon future operations of the buyer, the Company is recording its value as cash is received. On September 21, 2001, the Company sold all of the common stock of CCR for $3.1 million in cash and future payments contingent on the retention of certain customers subsequent to the sale. Since the gains or losses on these sales were estimated as of the measurement date of December 29, 2000, no additional adjustments were recorded to the estimated loss on the disposals of the discontinued businesses. Revenues from the information and property records services segment amounted to $39.7 million for the year ended December 31, 2000. One of the Company’s non-operating subsidiaries is involved in various claims for work-related injuries and physical conditions relating to a formerly owned subsidiary that was sold in 1995. During 2001 and 2000, the Company recorded net losses, net of related tax effect, of $3,000 and $748,000, respectively (See Note 17 in Notes to Consolidated Financial Statements). INVESTMENT SECURITY AVAILABLE-FOR-SALE Pursuant to an agreement with two major shareholders of HTE, the Company acquired approximately 32% of HTE’s common stock in two separate transactions in 1999. On August 17, 1999, the Company exchanged 2.3 million shares of its common stock for 4.7 million shares of HTE common stock. This initial investment was recorded at $14.0 million. The second transaction occurred on December 21, 1999, in which the Company exchanged 484,000 shares of its common stock for 969,000 shares of HTE common stock. This additional investment was recorded at $1.8 million. The investment in HTE common stock is classified as a non-current asset since it was made for a continuing business purpose. Florida state corporation law restricts the voting rights of “control shares,” as defined, acquired by a third party in certain types of acquisitions, which restrictions may be removed by a vote of the shareholders. The Florida “control share” statute has not been interpreted by the courts. HTE has taken the position that, under the Florida statute, all of the shares acquired by the Company constitute “control shares” and therefore do not have voting rights until such time as shareholders of HTE, other than the Company, restore voting rights to those shares. Management of the Company believes that only the shares acquired in excess of 20% of the outstanding shares of HTE constitute “control shares” and therefore believes the Company currently has the right to vote all HTE shares it owns up to at least 20% of the outstanding shares of HTE. On November 16, 2000, the shareholders of HTE, other than Tyler, voted to deny the Company its right to vote the “control shares” of HTE. On October 29, 2001, HTE notified the Company that it had attempted a cash redemption of all of the 5.6 million shares of HTE common stock currently owned by the Company at a price of $1.30 per share. Management of the Company believes that the attempted redemption of the Company-owned HTE shares was invalid and takes exception to the manner in which fair value was calculated. Management of HTE contends that its ability to redeem the shares of common stock owned by the Company and the manner of calculation of fair value by HTE is in accordance with Florida state statutes for “control shares.” On October 29, 2001, the Company notified HTE that its purported redemption of the shares owned by the Company was invalid and contrary to Florida law, and in any event, the calculation by HTE of fair value for such shares was incorrect. On October 30, 2001, HTE filed a complaint in a civil court in Seminole County, Florida requesting the court to enter a declaratory judgment declaring that HTE’s purported redemption 38 Tyler Technologies, Inc. of all of the Company-owned shares at a redemption price of $1.30 per share was lawful and to effect the redemption and cancel the Company-owned shares. The Company removed the case to the United States District Court, Middle District of Florida, Orlando Division and requested a declaratory judgment from the court declaring, among other things, (a) that HTE’s purported redemption of any or all of the shares held by the Company was illegal under Florida law, (b) in the alternative, that HTE’s right of redemption, if any, under Florida law only applies to the “control shares” owned by the Company (i.e., those shares in excess of 20% of the issued and outstanding shares of common stock of HTE as of the date that the Company acquired such shares), (c) in the alternative, that HTE’s calculation of fair value for the redemption of any or all of the shares owned by the Company was grossly understated, and (d) that the Company maintains the ability to vote up to 20% of the issued and outstanding shares of HTE common stock owned by the Company. Although the Company believes that the attempted stock redemption by HTE is invalid there can be no assurance that the court will rule in favor of the positions asserted by the Company. Under accounting principles generally accepted in the United States, an investment of 20% or more of the voting stock of an investee should lead to a presumption that in absence of evidence to the contrary, an investor has the ability to exercise significant influence over the operating and financial policies of an investee. Management of the Company has concluded that it currently does not have such influence as evidenced by the following key factors: • Inability to resolve the different interpretations regarding the ability to vote the shares; • Inability to obtain additional financial information not otherwise available to other shareholders; and • Inability to obtain certain confirmations and consents from the investee’s independent auditors. Accordingly, the Company accounts for its investment in HTE pursuant to the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” In accordance with SFAS No. 115, the Company used quoted market price per share in calculating fair value to be used for financial reporting purposes. SFAS No. 115 does not permit the adjustment of quoted market prices in the determination of fair value and, accordingly, the ultimate value the Company could realize because of its significant investment could vary materially from the amount presented. These securities are classified as available-for-sale and are recorded at fair value as determined by quoted market prices. Unrealized holding gains and losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of shareholders’ equity until realized. Realized gains and losses from the sale of available-for-sale securities (none in each of the three years ended December 31, 2001) are determined on a specific identification basis. A decline in the market value of any available-for-sale security below cost that is deemed to be other Tyler Technologies, Inc. 39 than temporary results in a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. Management of Tyler continues to conclude it has both the intent and the ability to hold the investment for a period of time sufficient to allow for the anticipated recovery in fair value. At this time, management of the Company does not believe the decline in the market value is other than temporary. In making this determination, management considered, among other items, the conditions in the local government software industry, the financial condition of the issuer, and recent public statements by the issuer concerning its future prospects. In addition, for a period of time during 2001 and in February 2002, the quoted market value price per share of HTE was above Tyler’s average per share cost basis of $2.81 per share. The cost, fair value and gross unrealized holding gains (losses) of the investment securities available-for-sale, based on the quoted market price for HTE common stock (amounts in millions, except per share amounts) are presented below: Quoted Market Price Per Share Gross Unrealized Holding Gains (Losses) Cost Fair Value December 31, 2001 December 31, 2000 February 21, 2002 $ 2.00 0.91 4.36 $ 15.8 15.8 15.8 $ 11.2 5.1 24.5 $ (4.6) (10.7) 8.7 NET INCOME AND OTHER MEASURES Net income was $269,000 in 2001 compared to a net loss of $24.6 million in 2000. For 2001, diluted earnings per share was $0.01 and, for 2000, diluted loss per share was $0.54. Income from continuing operations was $272,000, or $0.01 per diluted share in 2001, compared to a loss from continuing operations of $7.5 million, or $0.17 per diluted share in 2000. Earnings before interest, taxes, depreciation and amortization (“EBITDA”) from continuing operations for the year ended December 31, 2001, was $13.0 million, compared to EBITDA of $4.3 million in 2000. EBITDA consists of income or loss from continuing operations before interest, income taxes, depreciation, amortization and costs (recovery) of acquisition costs previously expensed. Although EBITDA is not calculated in accordance with accounting principles generally accepted in the United States, the Company believes that EBITDA is widely used as a measure of operating performance. Nevertheless, the measure should not be considered in isolation or as a substitute for operating income, cash flows from operating activities, or any other measure for determining the Company’s operating performance or liquidity that is calculated in accordance with accounting principles generally accepted in the United States. EBITDA is not necessarily indicative of amounts that may be available for reinvestment in the Company’s business or other discretionary uses. In addition, since all companies do not calculate EBITDA in the same manner, this measure may not be Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued) comparable to similarly titled measures reported by other companies. Cash provided by operating activities for the year ended December 31, 2001 was $12.7 million compared to cash used by operating activities of $7.1 million for the year ended December 31, 2000. 2000 COMPARED TO 1999 Because of the significance of certain of the Company’s acquisitions in 1999, in the following analysis of results of operations, the Company has provided pro forma amounts as if all of the Company’s acquisitions and dispositions previously discussed had occurred as of the beginning of 1999. There were no acquisitions since 1999 that remain in continuing operations. REVENUES On a pro forma basis, revenues were $93.2 million for the year ended December 31, 2000, compared to $107.4 million in the comparable prior year period. The decline in revenues on a pro forma basis was primarily because of post-Year 2000 (“Y2K”) related factors. Local governments reduced spending for software applications and systems in 2000 for a variety of reasons, including the acceleration of some projects into 1999 in anticipation of Y2K problems and the delay of some new systems projects in 2000 as they recovered from intensive efforts to become Y2K compliant in the prior year. Many customers and potential customers appeared to have instituted Y2K “lockdowns” and did not install new systems during 2000. Additionally, the 1999 pro forma revenues benefited somewhat from accelerated Y2K compliance related sales. Pro forma software license revenue in 2000 decreased approximately 25% to $18.6 million from $24.9 million in 1999. Pro forma software license revenue comparisons were negatively impacted by the post-Y2K factors described above. Professional service revenue on a pro forma basis decreased approximately $6.5 million to $37.4 million in 2000 from $43.9 million in 1999. Professional services such as data conversion and training are often contracted for in conjunction with software license sales. Thus, the decline in software license sales volume in 2000 negatively impacted related professional services revenues. Pro forma professional services revenue declined despite the inclusion of approximately $4.7 million of appraisal services and software revenue in 2000 from the Company’s contract with Nassau County. Pro forma maintenance revenue was $32.5 million for 2000 and $28.3 million for the comparable prior year period. The 15% increase is due to an increase in the Company’s base of installed software and systems products. Maintenance revenue was approximately 35% of total revenue in 2000 compared to approximately 26% in 1999, on a pro forma basis. Maintenance and support services are provided for the Company’s software products, including property appraisal products, and third party software and hardware. The renewal rates for property appraisal system maintenance agreements are not as high as other software and hardware maintenance agreements and will vary somewhat from period to period. Excluding property appraisal maintenance agreements, pro forma maintenance revenue increased approximately 20% for the year ended December 31, 2000 compared to the comparable prior year period. Hardware revenue on a pro forma basis decreased $5.7 million in 2000 compared to 1999 as a result of the Company focusing its sales effort on higher margin products and services. COST OF REVENUES For the year ended December 31, 2000, on a pro forma basis, cost of revenues was $58.9 million compared to $60.9 million in 1999. Gross margin, on a pro forma basis, decreased to 37% in 2000 from 43% for the same period in the prior year. Gross margin decreased because software license revenue was a lower percentage of the overall product mix in 2000 compared to 1999. Software license revenue carries higher margins than other revenue categories. Another factor contributing to a lower gross margin in 2000 was higher personnel costs. Personnel costs, which are the primary component of cost of service and maintenance revenue, increased due to higher costs of contract labor, salary adjustments and higher head count as a result of staffing increases associated with record high revenues in 1999. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE For the year ended December 31, 2000, selling, general and administrative expense was $32.8 million, or 35% of revenues. For the same period in the prior year, selling, general and administrative expense was $35.1 million, or 33% of revenues, on a pro forma basis. Selling, general and administrative expense include sales commission costs, which declined as a result of lower sales volume. This decline was offset somewhat by costs associated with consolidating certain finance and administrative functions and higher personnel costs. COSTS (RECOVERY) OF CERTAIN ACQUISITION OPPORTUNITIES In March 1999, the Company entered into a merger agreement pursuant to which the Company contemplated the acquisition of all of the outstanding common stock of CPS Systems, Inc. (“CPS”). In connection with that agreement, the Company provided CPS with bridge financing in the form of notes secured by a second lien on substantially all of the assets of CPS, including accounts receivable, inventory, intangibles, equipment and intellectual property. In January 2000, CPS filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code. On March 24, 2000, the bankruptcy court conducted a public auction of the assets of CPS. Accordingly, the aggregate bridge financings and related accrued interest receivable and other costs amounting to $1.9 million 40 Tyler Technologies, Inc. were expensed in the 1999 consolidated financial statements. In 2001 the Company received cash of approximately $235,000 through CPS bankruptcy proceedings in connection with the notes. The Company anticipates no further recovery of amounts due under its secured notes. AMORTIZATION OF ACQUISITION INTANGIBLES The Company has accounted for all acquisitions using the purchase method of accounting for business combinations. Unallocated purchase price over the fair value of net identifiable assets of the acquired companies (“goodwill”) and intangibles associated with acquisition are amortized using the straight-line method of amortization over their respective useful lives, commencing at the acquisition date. Amortization expense of acquisition intangibles increased $1.9 million from 1999 to $6.9 million in 2000 as the result of several acquisitions which occurred mid-year 1999. NET INTEREST EXPENSE Interest expense increased substantially for the year ended December 31, 2000 compared to the same period in 1999. The senior credit facility was amended in August 2000 and December 2000 to, among other things, accelerate repayment of borrowings under the facility. Accordingly, a cumulative $1.4 million charge was recorded in 2000 to accelerate the amortization of previously capitalized loan costs. Borrowings under the senior credit facility were used to finance acquisitions, as well as capital expenditures, including proprietary software development costs, resulting in higher interest expense. Capitalized software development costs were $6.7 million for 2000, as compared to $1.4 million for 1999. In addition to higher debt levels, the average effective interest rate for 2000 was 10.2% compared to 7.7% for 1999. INCOME TAX PROVISION In 2000, the Company had a pre-tax loss from continuing operations of $10.3 million and an income tax benefit of $2.8 million, resulting in an effective benefit rate of 27%. In 1999, the Company had a pretax loss from continuing operations of $1.8 million and an income tax provision of $188,000. The lower effective income tax benefit is due to non-deductible items such as goodwill amortization as compared to the relative amount of pretax loss. DISCONTINUED OPERATIONS The income (loss) from operations (net of income taxes) amounted to a loss of $4.3 million for the year ended December 31, 2000 and income of $1.9 million for the year ended December 31, 1999 and represents the operating income or loss of the information and property records services segment until their disposal measurement date of December 29, 2000. The loss on disposal (net of income taxes) amounting to $12.8 million for the year ended December 31, 2000 represents the gain or loss on the disposal of Kofile and of Resources, as Tyler Technologies, Inc. 41 well as the estimated loss on the anticipated disposals of the remaining businesses in this segment. In addition to the loss on disposal of information and property records services in 2000, the Company also recorded loss on disposal in 2000 and 1999 of $748,000 (net an income tax benefit of $403,000) and $1.9 million (net of an income tax benefit of $877,000), respectively, in connection with non-operating subsidiaries involved in various claims for work related injuries and physical conditions and for environmental claims relating to a formerly owned subsidiary that was sold in 1995. Also, the 1999 loss on disposal includes an additional loss of $907,000 (net of income taxes of $183,000) in connection with the automotive parts segment disposal. NET LOSS AND OTHER MEASURES Net loss was $24.6 million in 2000 compared to $2.8 million in 1999. Diluted loss per share was $0.54 and $0.07 for 2000 and 1999, respectively. Net loss from continuing operations was $7.5 million, or $0.17 per diluted share, in 2000 compared to net loss of $2.0 million, or $0.05 per diluted share, in 1999. ACCOUNTING PRONOUNCEMENTS NOT YET ADOPTED In June 2001, the Financial Accounting Standards Board (the “FASB”) issued SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 addresses the accounting and reporting of acquired goodwill and other intangible assets. SFAS No. 142 discontinues amortization of acquired goodwill and instead requires annual impairment testing of acquired goodwill. Intangible assets will be amortized over their useful economic life and tested for impairment in accordance with SFAS No. 142. Intangible assets with an indefinite useful economic life should not be amortized until the life of the asset is determined to be finite. The Company is required to adopt the provisions of SFAS No. 142 effective January 1, 2002. SFAS No. 142 will have a significant favorable impact on the Company’s 2002 financial results and beyond. See Note 1 in Notes to Consolidated Financial Statements for further discussion of the impact of SFAS No. 142. Also in June 2001, the FASB issued SFAS No. 141, “Business Combinations.” SFAS No. 141 requires that all business combinations be accounted for under the purchase method and defines the criteria for identifying intangible assets for recognition apart from goodwill. SFAS No. 141 applies to all business combinations initiated after June 30, 2001 and all business combinations accounted for using the purchase method for which the acquisition date is July 1, 2001 or later. The Company is required to adopt the provisions of SFAS No. 141 effective January 1, 2002. In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. Under SFAS No. 144, an impairment loss is recognized only if the carrying amount of a long-lived asset to be held and used is not recoverable from its undiscounted cash flows and the loss is Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued) measured as the difference between the carrying amount and the fair value of the asset. Long-lived assets to be disposed of by sale are to be measured at the lower of their carrying amount or fair value, less cost to sell, and depreciation related to such long-lived assets is required to be discontinued. In addition, SFAS No. 144 retains the basic provisions of APB Opinion No. 30 for the presentation of discontinued operations in the income statement but broadens that presentation to include a component of an entity rather than a segment of a business. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with early application encouraged. The provisions of this Statement generally are to be applied prospectively. The Company has not determined the effect of this new standard; however, due to the similarities with existing accounting standards regarding impairment losses, the impact is not expected to be material in the determination of carrying amounts for long-lived assets. FINANCIAL CONDITION AND LIQUIDITY During the year ended December 31, 2001, the Company had a revolving credit agreement with a group of banks (the “Senior Credit Facility”), which initially provided for borrowings up to $15.0 million and had a maturity date of July 1, 2002. After amendments to the Senior Credit Facility in May and September related to the sale of certain assets, the available borrowings were reduced to $7.0 million. Borrowings under the Senior Credit Facility bore interest at the lead bank’s prime rate plus a margin of 3%. The borrowings were limited to 80% of eligible receivables. In December 2001, the Company terminated the Senior Credit Facility. The effective average interest rates for borrowings under the Senior Credit Facility during 2001 and 2000 were 10.3% and 10.2%, respectively. On March 5, 2002, the Company entered into a new revolving credit agreement with a bank (the “2002 Credit Facility”) which has a maturity date of January 1, 2005 and provides for total availability of up to $10.0 million. Borrowings under the 2002 Credit Facility bear interest at either prime rate or at the London Interbank Offered Rate plus a margin of 3% and are limited to 80% of eligible accounts receivable. The 2002 Credit Facility is secured by substantially all of the Company’s personal property, and by a pledge of the common stock of the Company’s operating subsidiaries, and is also guaranteed by such subsidiaries. Under the terms of the 2002 Credit Facility, the Company is required to maintain certain financial ratios and other financial conditions and is also prohibited from making certain investments, advances, dividends or loans. The Company’s capitalization at December 31, 2001, consisted of $3.0 million in long-term obligations (including current portion) and $100.9 million in shareholders’ equity. The total debt-to-capital ratio was 2.9% at December 31, 2001. The Company leases certain offices, transportation, computer and other equipment used in its continuing operations under noncancelable operating lease agreements expiring at various dates through 2011. Most leases contain renewal options and some contain purchase options. Total future obligations under noncancelable leases and maturities of long-term debt at December 31, 2001, are as follows: 2002 - $3.2 million; 2003 - $2.7 million; 2004 - $2.4 million; 2005 - $4.7 million; 2006 - $1.6 million; subsequent to 2006 - $5.4 million. Payments in 2005 include a note payment of $2.8 million. For the year ended December 31, 2001, the Company made capital expenditures of $9.3 million for continuing operations. These expenditures included $6.2 million relating to software development costs. The remaining expenditures were primarily for computer equipment and expansions required to support internal growth. The Company also purchased a formerly leased building for $1.3 million in connection with an existing obligation of the discontinued information and property records service segment. Subsequent to December 31, 2001, the Company entered into a contract to sell the building for approximately $1.0 million in cash subject to the potential buyer securing financing for the purchase. The building is included in net assets of discontinued operations on the consolidated balance sheet at December 31, 2001. Capital expenditures in 2001 were primarily funded with cash generated from operations. Excluding acquisitions, Tyler anticipates that 2002 capital spending will be approximately $10.0 million, $6.5 million of which will be related to software development. Capital spending in 2002 is expected to be funded from cash flow from operations. 42 Tyler Technologies, Inc. On May 16, 2001, the Company sold all of the common stock of one of the remaining businesses that was previously designated as a discontinued operation. In connection with the sale, the Company received, among other consideration, cash proceeds of $575,000, and a promissory note of $750,000 payable in 58 monthly installments at an interest rate of 9%. On September 21, 2001, the Company sold all of the common stock of CCR, which had also been classified as a discontinued operation. The sale price of the common stock consisted of $3.1 million in cash, as well as future payments contingent on the retention of certain customers subsequent to the sale. On November 4, 1999, the Company acquired selected assets and assumed selected liabilities of Cole Layer Trumble Company (“CLT”) from a privately held company (“Seller”). A portion of the consideration consisted of the issuance of 1.0 million restricted shares of Tyler common stock and included price protection on the sale of the stock. The price protection, which expired November 4, 2001, was equal to the difference between the actual sale proceeds of the Tyler common stock and $6.25 on a per share basis, but was limited to $2.75 million. During the year ended December 31, 2001, the Seller submitted to Tyler a claim under the price protection provision which qualified for the maximum amount of the price protection. The purchase agreement contained a number of post-closing adjustments which resulted in a receivable of approximately $1.4 million due Tyler from the Seller. During the year ended December 31, 2001 and concurrent with the settlement of the price protection provision, Tyler paid the Seller $1.35 million in cash on a net basis and eliminated the aforementioned receivable. The two parties entered into a mutual release agreement to fully settle the price protection and related purchase agreement provisions. The Company is from time to time engaged in discussions with respect to selected acquisitions and expects to continue to assess these and other strategic acquisition opportunities as they arise. The Company may also require additional financing if it decides to make additional acquisitions. There can be no assurance, however, that any such opportunities will arise, that any such acquisitions will be consummated or that any needed additional financing will be available when required on terms satisfactory to the Company. Absent any acquisitions, the Company anticipates that cash flows from operations, working capital and available borrowing capacity under the 2002 Credit Facility will provide sufficient funds to meet its needs for at least the next year. Tyler Technologies, Inc. 43 Corporate Information C O R P O R A T E O F F I C E R S C O R P O R A T E H E A D Q U A R T E R S Louis A.Waters Chairman and Co-Chief Executive Officer John M.Yeaman President and Co-Chief Executive Officer Theodore L. Bathurst Vice President and Chief Financial Officer Brian K. Miller Vice President – Finance and Treasurer H. Lynn Moore, Jr. Vice President – General Counsel and Secretary Rick L. Hoff Chief Technology Officer Terri L. Alford Controller B O A R D O F D I R E C T O R S Louis A.Waters Chairman of the Board and Co-Chief Executive Officer Tyler Technologies, Inc. Ben T. Morris President and Chief Executive Officer Sanders Morris Harris Ulrich Otto Chairman and Chief Executive Officer Otto Holding B.V. G. Stuart Reeves Retired Executive Vice President Electronic Data Systems Corporation Glenn A. Smith President – Courts & Justice Division Tyler Technologies, Inc. John D.Woolf Executive Vice President and Chief Financial Officer eiStream, Inc. John M.Yeaman President and Co-Chief Executive Officer Tyler Technologies, Inc. 5949 Sherry Lane, Suite 1400 Dallas,Texas 75225 (214) 547-4000 www.tylertechnologies.com T R A N S F E R A G E N T A N D R E G I S T R A R EquiServe Trust Company, N.A. P. O. Box 43023 Providence, Rhode Island 02940-3010 (816) 843-4299 www.equiserve.com I N D E P E N D E N T A U D I T O R S Ernst & Young LLP Dallas,Texas L E G A L C O U N S E L Gardere Wynne Sewell LLP Dallas,Texas C O M M O N S T O C K Listed on the New York Stock Exchange under the symbol “TYL” I N V E S T O R I N F O R M A T I O N The Company’s Annual Report on Form 10-K is available on the Company’s Web site at www.tylertechnologies.com. A copy of the Form 10-K or other information may be obtained by contacting the Investor Relations department at corporate headquarters. I N V E S T O R R E L A T I O N S Tyler Technologies, Inc. (214) 547-4000 info@tylertechnologies.com 44 5949 Sherry Lane Suite 1400 Dallas, Texas 75225 (214) 547-4000 www.tylertechnologies.com 

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