T Y L E R T E C H N O L O G I E S A N N U A L R E P O R T 2 0 2 0 S T A B I L I T Y I N A N U N C E R T A I N W O R L D 5101 Tennyson Parkway, Plano, TX 75024 972.713.3700 T Y L E R T E C H . C O M A N N U A L R E P O R T 2 0 2 0 20sta b il i ty i n a n un cer ta in world 20 The public sector rose to the challenge. So did 2020 was perhaps the greatest test the public sector has ever known. Almost overnight, governments had to figure out how to navigate a worldwide pandemic, safely serve constituents and students, and enable employees to work remotely. As the world faced a global challenge, citizens relied on their government leaders for information and assistance. To help deliver answers and support, the public sector relied on the data, systems, and services provided by Tyler Technologies. Thanks to our decades of experience providing software and services for local, state, and federal governments of every size, no one knows the public sector quite like Tyler. We are proud of the role our team and solutions played in helping our clients navigate a year no one will soon forget. 1 IN 4 SCH OOL DIS TR ICTS I N THE U.S. USE A TYLER SOLUTION In 2020, Tyler helped schools navigate disruption by providing new solutions for contact tracing, seating charts, remote software implementations, bus routing plans for meal delivery, and Wi-Fi hotspots to connect school personnel with the students and the communities they serve. 25% U.S. school districts that use a Tyler solution / 0 1 TYLER TECHNOLOGIES ANNUAL REPORT 2020 A letter to our shareholders For more than 20 years, Tyler has compiled a remarkable record of financial success. While that trajectory continued in 2020, it was also unlike any year we’ve ever experienced. As the public sector managed its COVID-19 pandemic response, we delivered the stability our clients needed to navigate an uncertain world while continuing our growth. Along with the rest of the world, we experienced a significant impact on our operations from COVID-19. Our employees shifted to a 100% work-from-home model almost overnight as our offices across the country closed in the hope of reducing the spread of the virus. In-person client meetings, sales presentations, and implementations ground to a halt. But for our clients, a disruption to operations isn’t just inconvenient; it can significantly impact 2 0 2 0 AT A G L A N C E Thanks to the vital need for our solutions, we experienced another strong year financially despite overall economic headwinds. GAAP revenue rose 2.8% to $1.117 billion, while non-GAAP revenue increased 2.4% to $1.117 billion. GAAP net income for the year was $194.8 million, or $4.69 per diluted share, a change of 33% from 2019. Non-GAAP net income for the year was $229.3 million, or $5.52 per diluted share, up 7.8%. Most importantly, recurring revenues grew 12.6% and comprised 73% of our total revenues. Cash provided by operations grew 39.4%to $355.1 million, while free cash flow grew 53.6%, reaching a new high of $326.6 million. We finished 2020 with a backlog of $1.59 billion, up 9.4%. Some procurement processes and contracts encountered delays in 2020 due to the pandemic, but we are happy to report there were no meaningful cancelations. We entered 2021 with no debt, more than $750 million in cash and investments, and substantial additional liquidity available from our $400 million undrawn credit facility. While 39.4% Growth of cash provided by operations 53.6% Growth of free cash flow we took a pause from acquisitions in 2020, we plan to be In June, we were surprised and pleased to learn that Tyler had opportunistic in pursuing strategic acquisitions during the been added to the prestigious S&P 500 Index, representing coming years as we add leading companies and products to an incredible milestone in our growth. Tyler is the only complement our current offerings and support our growth technology company purely focused on the public sector in PRESIDENT & CEO H. LYNN MOORE, JR. the health, safety, and quality of life for the goals. In fact, in February 2021 we announced the signing of the S&P 500, which we see as a testament to our market citizens they serve. So we did what we do best: we rolled up our sleeves and began adapting our solutions and services to help the public sector As a result, we proved to be as essential to our clients as they are to their citizens. continue to meet the needs of constituents. the second quarter of 2021. a definitive agreement to acquire NIC, Inc. (NASDAQ: EGOV), leadership. Tyler’s stock continued its strong performance, a Kansas-based provider of digital government solutions for ending the year up 45.5%. state and federal governments for approximately $2.3 billion in cash. We are hopeful this acquisition will be completed in However, not all surprises were good ones. In September, we suffered a cybersecurity incident involving unauthorized access to our internal phone and information technology We continued to invest in product development at a high systems by an unknown third party. A thorough investigation level, increasing R&D expense 8.6% to $88.4 million. Our confirmed no evidence of malicious activity in Tyler- or client- R&D investments are increasingly focused on accelerating hosted systems as a result of this incident. We continue to our move to the cloud, as well as addressing our budding invest in our cybersecurity infrastructure to mitigate the risk strategic initiatives around payments. We also hired 169 net of future events as well as continuously improving the security new employees in 2020, many in R&D, while avoiding layoffs. of our products. 0 2 \ / 0 3 TYLER TECHNOLOGIES ANNUAL REPORT 2020 SIGNIFICANT P RO JECT WINS CONTI NU ING OUR CLOUD-FIRST STRATE GY We had another year of strong win rates across our solution suites as clients continue to optimize Thanks to our SaaS solutions, many of our public sector clients achieved the business continuity their use of data and technology across functions. Thanks to our broad portfolio of solutions, many they needed to serve constituents remotely while enabling employees to work from home in 2020. of our notable wins include existing clients adding new Tyler applications or new clients purchasing multiple Tyler solutions at once. All told, we closed 783 new deals representing every level of government and solution area. Notable Wins Include: • Renewing our contract with the Texas Office of Court Administration (OCA) to extend the use of Tyler’s eFileTexas™ electronic filing solution through August 2027 for $98 million, the largest single contract in Tyler’s history. • Winning a $5 million contract with the city of Jacksonville, Florida, for our New World® public safety records management and Brazos eCitation™ solutions, along with our Socrata™ data and insights, Scene Collect™, and SoftCode™ solutions. As the 13th largest city in the nation, this represents our largest public safety client to date. We also expanded our relationship with the city of Jacksonville through a $5 million contract for the EnerGov™ civic services suite, the largest software-as-a-service (SaaS) agreement for EnerGov to date. • Signing the first state-level contract for our new Tyler Supervision™ product with the state of Nevada. • Adding the Kansas 10th Judicial District Court in Johnson County as an additional court to the statewide agreement for Tyler’s Odyssey® case management and Tyler Supervision™ solutions, completing our statewide presence. $98M eFileTexas electronic filing contract $5M New World & Brazos eCitation contract signed with Jacksonville, Florida 783 New deals closed, represented by every level of government & solution area While we offer solutions in ways that fit the needs of our clients – be it on-premises, in the cloud, or as a hybrid approach – we continue to see the market shift to the cloud. In 2020, subscription revenue grew 18.3% to represent 62% of all new contract value. Subscription revenue growth has now exceeded 20% for 52 of the last 60 quarters. All business units have developed roadmaps for moving their product lines to a “cloud-first” approach, with analysis and development well under way in many solution areas. CEL EBRATI NG OUR EX TRAO RDINA RY TE AM More than any other highlight, the flexibility and perseverance of Tyler’s 5,500 employees emerged as our most important success story of the year. Tyler’s team members went above and beyond to serve clients while working from home, juggling their children’s remote learning needs, taking care of family members, and living with the daily stress of a pandemic. Thanks to them, our strategic initiatives remained on schedule or, in some cases, were accelerated; our client support experienced faster- than-average response times; and go-lives were able to be achieved remotely. We are beginning 2021 with a renewed sense of purpose. There is exciting work ahead of us and I am proud to be part of this Tyler team and the legacy we are building together. Beyond our technology and our strategy, it’s the passion and commitment of our people that makes Tyler an exceptional company. We look forward to building on our strong foundation to continue to deliver stability across the public sector. H. Lynn Moore, Jr. President & Chief Executive Officer March 1, 2021 0 4 \ / 0 5 TYLER TECHNOLOGIES ANNUAL REPORT 2020 F I N A N C I A L Y E A R I N R E V I E W 2020 GAA P OPERATING MARGIN 15.5% GAAP REVEN UE $1.117 billion B 5 . 1 $ N ON-GA A P RE VE N UE $1.117 billion B 5 . 1 $ 9 1 0 2 B 6 8 0 . 1 $ 9 1 0 2 B 1 9 0 . 1 $ NON-GA AP OPERATING M ARGIN 26.8% BACKLOG +9.4% FROM 2019 $1.59 billion 2020 BOOKINGS $1.3 billion GAAP NET INCOME $194.8 million NON-GAAP NET INCOME $229.3 million SUBSCRIPTION REVENUE $350.6 million RE V EN U E FROM SU B SCR I PT ION S 31.4% $500M 0 6 \ ANNUAL EARNINGS PER D ILU TED SH ARE GAAP NON-GAAP 2018 2019 2020 $3.68 $3.65 $0 $1 $2 $3 $4 $4.80 $4.69 $5 $5.30 $5.52 $6 / 0 7 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Delivering without disruption We entered 2020 with the wind at our back. Thanks to record-setting performance in 2019, we were prepared to leverage our strong financial position, win rates, and client success to make this our best year yet. But by mid-March, the world went into lockdown due to the COVID-19 pandemic. As the vital infrastructure that keeps society on track, the public sector had to continue to serve constituents while navigating unprecedented obstacles and uncertainty. We quickly adapted the way we do business to meet the realities of the pandemic. Within days, we closed our offices around the country and transitioned our 5,500 employees to a 100% remote work model. While we experienced some delays in sales processes and implementations, our team continued to provide client support, deliver product training, and conduct virtual sales demos. We also adapted many applications to help clients navigate their pandemic response, such as: • Using our Socrata Connected Government Cloud™ to help the U.S. Centers for Disease Control and Prevention (CDC) collect data about hospital bed and ventilator availability across 5,300 facilities to share with the public. • Optimizing public safety products to alert first responders to incidents involving positive COVID-19 cases and advising of the need for personal protection equipment before arriving on scene. • Creating new home screen buttons on the MyCivic™ app to help residents easily find COVID-19 information. • Offering Munis® and Open Finance™ integrations to increase transparency into pandemic-related expenses. • Using our Traversa® and Versatrans® transportation solutions to plan meal drop-off routes for families in need. • Creating a new Tyler Bus Attendance™ app to help school districts manage contact tracing, and integrating contact tracing reports between Traversa and Tyler SIS™ for bus-to-school-to-bus reporting. 1,200 Remote go-lives in 2020 0 8 \ 325 On-demand webinars for education and training as an alternative to the Connect user conference 19,455 Online views of user training as an alternative to our annual Connect user conference TYLER TECHNOLOGIES ANNUAL REPORT 2020 Another example of our agility in action is the change we Meanwhile, we canceled our annual in-person user conference made to our implementation process. Before the pandemic, Tyler Connect and shifted to an online offering called Still this process traditionally required Tyler employees to travel and Connected that let us share more than 325 on-demand be on site at the client’s location. With shelter-in-place orders educational webinars and training programs. Still Connected preventing employee travel or in-person client interactions, achieved more than 19,455 visitors watching nearly 18,000 many of our clients feared they would need to delay their hours of content, enabling us to reach even more users than planned go-lives indefinitely. Instead, we redesigned the our traditional in-person conference. process to allow for remote go-lives, keeping complex projects on track while giving clients the essential technology they need. In all, we conducted nearly 1,200 remote go-lives in 2020. / 0 9 SOLUTION SNAPSHOT: COURTS & J UST ICE JUST ICE KNOWS NO BOUNDA RIES Forced to close during the pandemic, the Alvin Municipal Court in Texas was at risk of delaying citizens’ court dates indefinitely. Thanks to the accelerated launch of Tyler Virtual Court™, the court could still provide essential access to court services while ensuring the health and safety of court employees and defendants. “Tyler Virtual Court allows us to serve our citizens without interruptions, especially during this uncertain time while shelter-in-place regulations are in effect. We will also be able to better assist defendants during impending natural disasters like hurricanes and flooding,” said Sonya Cates, court administrator, city of Alvin Municipal Court. As a result of the Alvin Municipal Court implementation, Tyler Virtual Court was named the 2020 Amazon Web Services (AWS) Public Sector Partner Award winner for “Best Remote Work Solution.” Thanks to the accelerated launch of Tyler Virtual Court™, Alvin Municipal court was able to provide citizens with access to essential court services from the safety of home. 1 0 \ / 1 1 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Looking ahead to 2021 We believe the best days for Tyler are still to come. Here’s why. Our fundamentals have never been stronger. We entered 2021 with zero debt, more than $750 million in cash and investments, and substantial additional liquidity available through our $400 million undrawn credit facility. We’ve survived and thrived through crises. Our decades of experience include navigating the fallout of Y2K, the dot- com crash, 9/11, and the Great Recession. Each time, Tyler emerged stronger and in an improved competitive position. We’re ready to expand. After conducting eight acquisitions since 2018, we paused acquisition activity in 2020 to focus on managing our pandemic response and to further integrate those acquisitions into our portfolio. As we move forward, we expect to pursue strategic acquisition opportunities to further improve our competitive positioning and add new solutions to our product lines. We’re investing in the future. We continued to expand our R&D initiatives throughout 2020, investing $94 million in new product innovation. We also added 40 new R&D team members to our ranks, allowing us to accelerate strategic initiatives such as our cloud transition. We’re positioned to win. Our previous investments in M&A and R&D give us a competitive position that is stronger than ever, helping us significantly increase our total addressable market and secure new business. / 1 3 E S N E P X E D & R 9 1 0 2 M 1 8 $ E S N E P X E D & R 0 2 0 2 M 8 8 $ E S N E P X E D & R 8 1 0 2 M 3 6 $ E S N E P X E D & R 7 1 0 2 M 7 4 $ 1 2 \ TYLER TECHNOLOGIES ANNUAL REPORT 2020 98% Client retention rate Building solutions that build connections Our clients increasingly realize the value of technology to connect data sources, enable collaboration, and improve the citizen experience; over the past year, the limitations of outdated technology were laid bare. We expect the experience of 2020 to accelerate the prioritization of digital transformation initiatives in 2021 and beyond. While many of our public sector clients face near-term budget pressure, our client base is unique in that they can’t go out of business. The demand for our solutions is more pressing than ever: we estimate that well over half of the systems currently used by public sector entities are homegrown or from non-competitive vendors, with many systems decades old or no longer supported. The total annual spend on application and vertical-specific software and IT by state and local government and education is more than $108 billion. With $1.117 billion in revenues in 2020, we’ve only scratched the surface of how far we can go. Our success is not dependent on any single market, product or vertical. Our broad national footprint, along with our 98% client retention rate, positions us to continue to expand into new departments with existing clients. In addition, we are now perfectly positioned to win deals with Tier 1 cities and the federal government, such as the contract we signed in December with the U.S. Department of Health & Human Services to replace Healthcare.gov, the primary government website for critical, publicly-available health data. As the largest technology solution provider singularly focused on the public sector, we are far better positioned than our competitors to take advantage of new opportunities to serve our clients and grow our business. $108B State and local government and education spend on application software $1.117B 2020 record of revenues for Tyler Technologies >50% Outdated public sector systems 1 4 \ / 1 5 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Our employees are our most valuable asset We grew our workforce by 3% in 2020, adding more than 160 net new employees. Our people continue to be one of our key competitive differentiators. No other company has the depth of public sector experience that Tyler brings to every client engagement. In fact, 40% of our employees have previously worked in the public sector. We know what it’s like to walk in our clients’ shoes, which allows us to build and deliver solutions uniquely suited to serving the public. To continue to attract the best and the brightest, we work hard to create winning work environments across the country. Tyler was named to several “best places to work” lists, including those in Albany, New York; Atlanta, Georgia; Dallas-Fort Worth, Texas; Detroit, Michigan; the state of Maine; and Washington, D.C., along with being named to the Forbes “Best Employers for Diversity” list. To further strengthen our team, we added leadership roles in Talent Development, Compensation, and HRIS & Workforce Analytics. These roles expand our focus on workforce and leadership development, diversity, equity, and an inclusive team member experience to ensure we continue to compete for and develop top tech talent. 3% Net employee growth in 2020 (with no layoffs) 40% Tyler Technologies employees who previously worked in the public sector SOLU TIO N SNA PSHOT: ERP S OLUT IO NS ENSURING SUCCES S F ROM A N Y WHERE With 111 schools and 107,379 students, Georgia’s Cobb County School District (CCSD) is the second largest school district in the state. Like other large organizations with a multitude of business and financial processes, CCSD faced a challenge when having to shift to remote work during the onset of the COVID-19 crisis. Having recently replaced siloed legacy financial systems with Tyler’s Munis ERP solution, CCSD was able to keep remote staff operating efficiently using integrated applications for financial management, human capital management, content management, and asset management. “We have a level of cohesiveness in our departments and across divisions that we did not have before,” said Nancy Tolbert, director of financial systems and capital assets, Cobb County School District, Georgia. “An integrated system has provided the opportunity to evaluate and improve business processes and to better handle the challenges of a remote work environment.” The Cobb County School District relied on their integrated Munis ERP solution to give remote staff the comprehensive access to data they needed to continue to work. 1 6 \ / 1 7 T YLER CORPORATE OFFICERS & OPERATIONAL LEADERSHIP TYLER TECHNOLOGIES ANNUAL REPORT 2020 Creating new products and new opportunities Thanks to our ongoing commitment to R&D, this year we launched a number of new products while further integrating our recent acquisitions into our portfolio. Our new product launches include: Tyler Virtual Court: By allowing courts to handle cases remotely, this solution removes the burden of requiring defendants to physically appear in a courtroom for traffic violations. Not only does Tyler Virtual Court improve overall access and efficiency, but it is a critical solution for keeping the justice system in motion despite closed courtrooms. Originally planned to launch during Tyler Connect in April 2020, we accelerated the launch of Tyler Virtual Court in response to the pandemic and offered it without charge to clients for the first 90 days, so they could continue to hear court cases without interruption. More than 57 court systems serving over 2 million citizens adopted Tyler Virtual Court in 2020. Electronic Warrants™: This cloud-native, mobile-friendly application allows law enforcement officers to submit warrant requests from the field while enabling judicial officers to process those requests at any time of day or night. By providing a secure and flexible means to expedite warrant processing, valuable evidence can be preserved while ensuring due process is served. Assessment Connect™: This solution provides property assessors with real-time data and insights into the complete property valuation lifecycle, helping county, municipal, and state assessing offices create fair and equitable property valuations throughout their jurisdictions. Executive Insights™: This dashboard enables public sector decision-makers to access all their financial data to improve forecasting and budgets. By combining metrics like revenue, payroll, cash balances, and other key data in one dashboard, leaders can make smarter, more informed decisions about allocating resources. In addition, we also completed the integration of our 2019 acquisition of MicroPact as our new Federal Division. Thanks to the acquisition, we grew our total addressable market by $2 billion by expanding our capabilities across new solution areas like health and human services. Major Federal Division initiatives this year include: • Providing a commercial Vocational Rehabilitation & Employment case management solution to the U.S. Department of Veterans’ Affairs (VA) Veterans Benefits Agency via a consortium of four Tyler Platform Alliance Partners so vocational rehabilitation counselors can better manage cases effectively using automated business processes. • Working with the New York State Division of Veterans Services to add capabilities to its Entellitrak®-based Veterans’ Benefits solution so it could continue to serve veterans remotely during the pandemic. • Partnering with Cerner Corporation to help state health departments more efficiently complete federally mandated Medicaid reporting using Tyler’s Entellitrak platform. 1 8 \ / 1 9 TYLER TECHNOLOGIES ANNUAL REPORT 2020 SOLUTI ON SNAPSHOT: P UBLIC SAF ETY PROT ECT ING T HE PROT EC TORS To help protect its first responders during the pandemic, the Douglas County Sheriff’s Office in Colorado customized its Tyler computer-aided dispatch (CAD) solution to provide dispatchers with alerts when sending law enforcement to locations where individuals have tested positive for COVID-19. This helps the first responder prepare with personal protection equipment before arriving on the scene, which maximizes the safety of the responder and those involved in the call for service. “We look at this as an opportunity to be safe and make a difference for the first responders who are on the front lines already,” Douglas Regional Communications Manager Grace Reinis said. The Douglas County Sheriff’s Office relied on their Tyler computer-aided dispatch (CAD) solution to prepare first responders for the unique needs of providing service during a pandemic. 2 0 \ / 2 1 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Marking success with acquisition results In October 2020, we celebrated the fifth anniversary of the New World Systems acquisition. Although New World was already a leader in mid-market public safety solutions, under Tyler’s ownership these solutions evolved to meet the needs of the changing public safety landscape through increased investment and integration with our other justice solutions. In addition, Tyler’s investment in New World products has enabled us to serve larger jurisdictions and meet the needs of some of the United States’ largest jurisdictions. In the past five years, more than 360 clients have gone live provides instant access to real-time data on smartphones, with New World solutions, product upgrades have accelerated, smartwatches, and tablets. With these capabilities, command and public safety win rates have improved significantly. staff and dispatchers also have more insight into each call for Our investment in new public safety product research and service, which helps to fulfill Tyler’s commitment to helping development continues, growing from $9.5 million in 2016 agencies make communities safer. to a planned $24.4 million in 2021. The public safety team has added nine products, with three additional applications currently in development. The evolution of New World serves as an example of Tyler’s overall approach to acquisitions. By investing in the acquired company’s products and personnel and taking the time to fully These solutions enhance safety and awareness for first integrate them into our culture and portfolio, Tyler strengthens responders in the field by utilizing mobile technology that the business and positions the product line for greater success. 360 public safety client go-lives in the past five years 2016 $9.5M 2021 $24.4M 2 2 \ / 2 3 Investment in new public safety research and development from Tyler’s New World Systems acquisition. TYLER TECHNOLOGIES ANNUAL REPORT 2020 SOLUT ION SNAPS HOT: CIVIC S ERV ICES GOING PA PERL ES S IN A PA NDEMIC The city of El Cajon, California, had already moved a handful of business permits to online self-service when the pandemic struck. “Our goal is to give you options for almost every form of government so you can do it from your jammies,” said Sara Diaz, the city’s To keep new construction moving during the pandemic, the city worked with Tyler to move completely to paperless permitting in 30 IT director. “We’re currently evaluating every single contact that people have when they come to city hall — why they come — and days, a process originally expected to take a year. In the first quarter that online permitting processing was live, the city processed seeing if we can find an online alternative. We’ll never take away city hall, but we want people to have that option, and I see that $386,000 in permit and plan fees online. continuing after the pandemic.” TYLER TECHNOLOGIES ANNUAL REPORT 2020 To ensure new construction could still take place during the pandemic, Tyler worked with the city of El Cajon to help them transition to a paperless permitting process in just 30 days. 2 4 \ / 2 5 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Connecting communities through the cloud This year, we leveraged our strategic relationship with Amazon Web Services (AWS) to accelerate value delivery, enable more connected citizenry, and improve the capabilities of our applications. In recognition of our innovation, Tyler received the 2020 AWS Public Sector Partner Award for “Best Remote Work Solution” for our Tyler Virtual Court product. We also earned the AWS Healthcare Competency for our Entellitrak case management platform, which differentiates Tyler as an AWS Partner Network (APN) member by demonstrating our relevant technical proficiency and proven client success. As we look to the future, the demand for cloud-based solutions from the public sector is clear. We are seeing more RFPs that specify cloud solutions, making it imperative we continue to transform from a cloud-agnostic software provider to one that is cloud-first. In addition, the more we can connect applications in the cloud, the more effectively we’ll be able to execute our vision of Connected Communities to connect workflows and processes across departments, agencies, and geographic boundaries. 2 6 \ / 2 7 TYLER TECHNOLOGIES ANNUAL REPORT 2020 SOLU TI ON SNA PSHOT: APPRA ISAL & TA X RE AS SES SING HOW TO DO BUSINES S Property assessments are the lifeblood for funding community services. When the pandemic threatened to cancel necessary in- person assessment hearings for Delaware County, Pennsylvania, Tyler worked with county officials to quickly pivot to an all-phone hearing schedule. In order to use cell phones and remote access to Tyler’s iasWorld® assessment software to conduct property reviews, 27 virtual private networks (VPNs) had to be created and tested for remote employees, while property owners with scheduled hearings were notified via automated calls and text messages. By the fourth week of hearings, 17 hearing officers were operating remotely, and more than 5,500 phone appointments were completed, comprising 67% of the full schedule. “The biggest challenges were scrapping a plan that took months of preparation for a new plan in under 24 hours,” said John Van Zelst, Delaware County assessment manager. Pennsylvania’s Delaware County worked with Tyler to create an all-phone property assessment hearing process so that they could conduct property reviews remotely as scheduled. 2 8 \ / 2 9 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Making a positive impact beyond our products Tyler’s commitment to building stronger communities is not just evident in the work we do, but also in the way our team members engage with the cities where we work and live. In 2020, we published our first corporate social responsibility report to document our commitment to the environment, our communities, and our employees. We also established an Environmental, Social, and Governance (ESG) Council to ensure critical social issues are considered when making business decisions. The Tyler Foundation, our endowment for charitable giving, continues to support local nonprofits throughout our communities. In 2020, Tyler made nearly $1.25 million in monetary and in-kind donations through employee contributions and the Tyler Foundation. Tyler employees also gave more than 3,300 hours of their time volunteering for charitable events in their communities. In addition, we continued our close partnership with the nonprofit Both Ends Believing to provide our Children First™ software so institutions and orphanages around the world can create digital profiles of children. In doing so, social workers are able to optimize case tracking and use data to be better advocates when matching children with permanent families. $1.25M in monetary and in-kind donations 3,300 hours of volunteer time for charitable events SOLU TIO N SNA PSHOT: DATA & I NSIGHTS REDUCING T HE SPRE A D OF MISINFORM AT ION As the second-largest city in New York, Buffalo needed a way to quickly communicate accurate information to city hall staff and constituents as a part of its pandemic response. The city launched Tyler’s Socrata® solution to create a comprehensive COVID-19 resource portal that internal staff and the public could use to access accurate physical and mental health information, assistance for small businesses, information on homeless shelters, and support for older residents. “One of the issues faced by the city, health care providers, and emergency first responders is misinformation that has been presented as fact,” said Buffalo Mayor Byron Brown. “It’s critically important that people get accurate information so they can make the proper health care decisions for themselves that have an impact, not only on their health, but their family members’ and their friends’ health as well.” The city of Buffalo used Tyler’s Socrata® solution to provide citizens and internal staff with equal access to comprehensive COVID-19 resources. 3 0 \ / 3 1 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Stability starts with strong connections While it certainly wasn’t the year we had planned for, this year drove home the importance of data and technology for the public sector. With community leaders, government employees, and constituents alike all stuck at home, Tyler made it possible for people to connect. Thanks to our strong financial position, innovative products, and our incredible people, Tyler rose to the challenge of 2020 to serve the public sector in their time of urgent need. We believe our success in meeting these challenges will ultimately serve as the foundation for new opportunities in 2021 and beyond. 3 2 \ I E S Y L E R 2 0 2 0 R E P O R T A N N U A L T E C H N O L O G 20T 20 2020 F IN A NCI A L INFORM AT ION Reconciliation of GAAP to NON-GAAP Financial Measures (Unaudited) Stock Market Data TYLER TECHNOLOGIES ANNUAL REPORT 2020 (In thousands, except per share data) RECONCILIATION OF NON-GAAP TOTAL REVENUES GAAP total revenues Non-GAAP adjustments: Add: Write-downs of acquisition-related deferred revenue Add: Amortization of acquired leases Non-GAAP total revenues RECONCILIATION OF NON-GAAP GROSS PROFIT AND MARGIN GAAP gross profit Non-GAAP adjustments: Add: Write-downs of acquisition-related deferred revenue Add: Amortization of acquired leases Add: Share-based compensation expense included in cost of revenues Add: Amortization of acquired software Non-GAAP gross profit GAAP gross margin Non-GAAP gross margin RECONCILIATION OF NON-GAAP OPERATING INCOME AND MARGIN GAAP operating income Non-GAAP adjustments: Add: Write-downs of acquisition-related deferred revenue Add: Amortization of acquired leases Add: Share-based compensation expense Add: Employer portion of payroll tax related to employee stock transactions Add: Acquisition-related costs Add: COVID-19 incremental costs Add: Amortization of acquired software Add: Amortization of customer and trade name intangibles Non-GAAP adjustments subtotal Non-GAAP operating income GAAP operating margin Non-GAAP operating margin RECONCILIATION OF NON-GAAP NET INCOME AND EARNINGS PER SHARE GAAP net income Non-GAAP adjustments: Add: Total non-GAAP adjustments to operating income Less: Tax impact related to non-GAAP adjustments Non-GAAP net income GAAP earnings per diluted share Non-GAAP earnings per diluted share DETAIL OF SHARE-BASED COMPENSATION EXPENSE Cost of software services, maintenance and subscriptions Selling, general and administrative expenses Total share-based compensation expense RECONCILIATION OF FREE CASH FLOW Net cash provided by operating activities Less: additions to property and equipment Less: capitalized software development costs Free cash flow 3 4 \ 2020 2019 2018 $ 1,116,663 $ 1,086,427 $ 935,282 478 313 $ 1,117,454 4,557 372 $ 1,091,356 4,000 426 $ 939,708 $ 542,512 $ 516,900 $ 439,578 478 313 18,125 31,962 $ 593,390 4,557 372 15,002 30,642 $ 567,473 4,000 426 13,588 22,972 $ 480,564 48.6% 53.1% 47.6% 52.0% 47.0% 51.1% $ 172,926 $ 156,367 $ 152,492 478 313 67,365 3,294 — 1,537 31,962 21,662 $ 126,611 $ 299,537 4,557 372 59,967 1,745 1,142 — 30,642 21,445 $ 119,870 $ 276,237 4,000 426 52,740 1,412 — — 22,972 16,217 $ 97,767 $ 250,259 15.5% 26.8% 14.4% 25.3% 16.3% 26.6% $ 194,820 $ 146,527 $ 147,462 126,611 (92,175) $ 229,256 $ $ 4.69 5.52 $ 18,125 49,240 $ 67,365 $ 355,089 (22,690) (5,776) $ 326,623 119,870 (53,819) $ 212,578 $ $ 3.65 5.30 $ 15,002 44,965 $ 59,967 $ 254,720 (37,236) (4,804) $ 212,680 97,767 (52,464) $ 192,765 $ $ 3.68 4.80 $ 13,588 39,152 $ 52,740 $ 250,203 (27,424) — $ 222,779 Our common stock is traded on the New York Stock Exchange under the symbol “TYL”. At December 31, 2020, we had approximately 1,143 stockholders of record. Most of our stockholders hold their shares in street name; therefore, there are substantially more than 1,143 beneficial owners of our common stock. 2019 2020 First Quarter Second Quarter Third Quarter Fourth Quarter First Quarter Second Quarter Third Quarter Fourth Quarter High Low $ 217.89 233.15 265.00 301.39 $ 340.80 382.92 374.98 466.21 $ 176.27 203.77 217.19 245.00 $ 247.22 275.38 319.58 346.45 We did not pay any cash dividends in 2020 or 2019. Our bank credit agreement contains restrictions on the payment of cash dividends. We intend to retain earnings for use in the operation and expansion of our business and do not anticipate paying a cash dividend in the foreseeable future. / 3 5 TYLER TECHNOLOGIES ANNUAL REPORT 2020 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Selected Financial Data (In thousands, except per share data) STATEMENT OF OPERATIONS DATA: Revenues Cost and expenses: Cost of revenues Selling, general and administrative expenses Research and development expense Amortization of customer and trade name intangibles Operating income Other income, net Income before income taxes Income tax (benefit) provision Net income Net earnings per diluted share Weighted average diluted shares STATEMENT OF CASH FLOWS DATA: Cash flows provided by operating activities Cash flows used by investing activities Cash flows (used) provided by financing activities BALANCE SHEET DATA: Total assets Revolving line of credit Shareholders’ equity For the Years Ended December 31, 2020 2019 2018 $ 1,116,663 $ 1,086,427 $ 935,282 574,151 259,561 88,363 21,662 172,926 2,116 175,042 (19,778) 194,820 569,527 257,746 81,342 21,445 156,367 3,471 159,838 13,311 146,527 495,704 207,605 63,264 16,217 152,492 3,378 155,870 8,408 147,462 $ 4.69 $ 3.65 $ 3.68 41,526 40,105 40,123 $ 355,089 (98,320) 114,172 $ 254,720 (245,015) 88,698 $ 250,203 (238,255) (63,595) $ 2,607,274 — 1,986,111 $ 2,191,614 — 1,617,058 $ 1,790,963 — 1,324,846 Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included in this Annual Report. For a comparison of our Results of Operations for the years ended December 31, 2019 and 2018 and our Cash Flow discussion for the year ended December 31, 2019, see “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” of our Annual Report for the year ended December 31, 2019. FORWARD-LOOKING STATEMENTS In addition to historical information, this Annual Report contains forward-looking statements. The forward-looking statements are made in reliance upon safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinion only as of the date hereof. We undertake no obligation to revise or publicly release the results of any revisions to these forward-looking statements. Readers should carefully review the risk factors described in documents we file from time to time with the Securities and Exchange Commission. When used in this Annual Report, the words “believes,” “expects,” “anticipates,” “foresees,” “forecasts,” “estimates,” “plans,” “intends,” “continues,” “may,” “will,” “should,” “projects,” “might,” “could” or other similar words or phrases are intended to identify forward-looking statements. Similarly, statements that describe our business strategy, outlook, objectives, plans, intentions or goals also are forward-looking statements. OVERVIEW General We provide integrated information management solutions and services for the public sector, with a focus on local governments. We develop and market a broad line of software products and services to address the IT needs of cities, counties, schools and other local government entities. In addition, we provide professional IT services to our clients, including software and hardware installation, data conversion, training and for certain clients, product modifications, along with continuing maintenance and support for clients using our systems. We also provide subscription-based services such as software as a service (“SaaS”), which primarily utilize the Tyler private cloud, and electronic document filing solutions (“e-filing”), which simplify the filing and management of court related documents. Revenues for e-filing are derived from transaction fees and, in some cases, fixed fee arrangements. Other transaction-based fees primary relate to online payment services. We also provide property appraisal outsourcing services for taxing jurisdictions. Our products generally automate eight major functional areas: (1) financial management and education, (2) courts and justice, (3) public safety, (4) property appraisal and tax, (5) planning, regulatory and maintenance, (6) land and vital records management, (7) data and insights and (8) platform technologies. We report our results in two segments. The Enterprise Software (“ES”) segment provides public sector entities with software systems and services to meet their information technology and automation needs for mission-critical “back-office” functions such as: financial management and education, courts and justice, public safety, planning, regulatory and maintenance, data and insights and platform technologies. The Appraisal and Tax (“A&T”) segment provides systems and software that automate the appraisal and assessment of real and personal property, land and vital records management as well as property appraisal outsourcing services for local governments and taxing authorities. Property appraisal outsourcing services include: the physical inspection of commercial and residential properties; data collection and processing; computer analysis for property valuation; preparation of tax rolls; community education; and arbitration between taxpayers and the assessing jurisdiction. As of January 1, 2020, the land and vital records management business unit, which was previously reported in the ES segment, was moved to the A&T segment to reflect changes in the way in which management makes operating decisions, allocates resources, and manages the growth and profitability of the Company. Prior year amounts for the ES and A&T segments have been adjusted to reflect the segment change. Refer to Note 14 — “Segment and Related Information” for further information. For the twelve months ended December 31, 2020, total revenues increased 2.8% compared to the prior year. Excluding the impact of acquisitions, total revenues increased 1.4% compared to prior year. Revenues from acquisitions contributed 1.4% of growth for the twelve months ended December 31, 2020. 3 6 \ / 3 7 TYLER TECHNOLOGIES ANNUAL REPORT 2020 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Management’s Discussion and Analysis of Financial Condition and Results of Operations Management’s Discussion and Analysis of Financial Condition and Results of Operations Subscriptions revenue grew 18.3% for the twelve months ended December 31, 2020, due to a gradual shift toward cloud-based, software as a service business, as well as continued strong growth in our transaction-based revenues from online payments and e-filing revenues from courts. Excluding the impact of recent acquisitions, subscriptions revenue increased 17.2% for the twelve months ended December 31, 2020. Our backlog at December 31, 2020 was $1.59 billion, a 9.4% increase from last year. We monitor and analyze several key performance indicators in order to manage our business and evaluate our financial and operating performance. These indicators include the following: Revenues — We derive our revenues from five primary sources: sale of software licenses and royalties; subscription-based arrangements; software services; maintenance; and appraisal services. Subscriptions and maintenance are considered recurring revenue sources and comprised approximately 73.3% of our revenue in 2020. The number of new SaaS clients and the number of existing clients who convert from our traditional software arrangements to our SaaS model are a significant driver of our revenue growth, together with new software license sales and maintenance rate increases. In addition, we also monitor our customer base and churn as we historically have experienced very low customer turnover. During 2020, based on our number of customers, turnover was approximately 2%. Cost of Revenues and Gross Margins — Our primary cost component is personnel expenses in connection with providing software implementation, subscription-based services, maintenance and support, and appraisal services to our clients. We can improve gross margins by controlling headcount and related costs and by expanding our revenue base, especially from those products and services that produce incremental revenue with minimal incremental cost, such as software licenses and royalties, subscription-based services, and maintenance and support. Our appraisal projects are cyclical in nature, and we often employ appraisal personnel on a short-term basis to coincide with the life of a project. As of December 31, 2020, our total employee count increased to 5,536 from 5,368 at December 31, 2019. Selling, General and Administrative (“SG&A”) Expenses — The primary components of SG&A expenses are administrative and sales personnel salaries and commissions, share-based compensation expense, marketing expense, rent and professional fees. Sales commissions typically fluctuate with revenues and share-based compensation expense generally increases as the market price of our stock increases. Other administrative expenses tend to grow at a slower rate than revenues. Liquidity and Cash Flows — The primary driver of our cash flows is net income. Uses of cash include acquisitions, capital investments in property and equipment and discretionary purchases of treasury stock. Our working capital needs are fairly stable throughout the year with the significant components of cash outflows being payment of personnel expenses offset by cash inflows representing collection of accounts receivable and cash receipts from clients in advance of revenue being earned. In recent years, we have also received significant amounts of cash from employees exercising stock options and contributing to our Employee Stock Purchase Plan. Balance Sheet — Cash, accounts receivable and days sales outstanding and deferred revenue balances are important indicators of our business. Impact of the COVID-19 Pandemic In March 2020, the World Health Organization declared the outbreak of a COVID-19 pandemic, which continues to spread throughout the U.S. and the world and has resulted in authorities implementing numerous measures to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders, and business limitations and shutdowns. While we are unable to accurately predict the full impact that COVID-19 will have on our results from operations, financial condition, liquidity and cash flows due to numerous uncertainties, including the duration and severity of the pandemic and containment measures and associated compliance, the current environment has negatively impacted our revenues for fiscal year 2020. Because an increasing portion of our revenues are recurring, the effect of COVID-19 on our results of operations may also not be fully reflected for some time. We continue to see some impact on our business in the near term with delays in government procurement processes and uncertainty around public sector budgets, as well as delays in implementations caused by travel restrictions, closed offices, or clients shifting focus to more pressing issues. We have addressed those challenges through adapting the way we do business — encouraging web and video conferencing, conducting virtual sales demonstrations and delivering professional services remotely. Our priorities during this crisis are protecting the health and safety of our employees and our clients. Our IT systems and applications support a remote workforce. Prior to the pandemic, many of our employees worked remotely. In response to the pandemic, we encouraged all employees who are able to do so to work from home, equipping them with resources necessary to continue uninterrupted. We were able to transition the vast majority of our employees to this work-from-home posture. This reduces the number of team members in our offices to those uniquely needed for essential on-site services, such as network operations support staff, and allows for “social distancing” as directed by the Centers for Disease Control (“CDC”). The pandemic has delayed some government procurement processes and is expected to impact our ability to complete certain implementations, negatively impacting our revenue. It could also negatively impact the timing of client payments to us. We continue to monitor these trends in order to respond to the ever-changing impact of COVID-19 on our clients and Tyler’s operations. For the twelve months ended December 31, 2020, the impact of the COVID-19 pandemic resulted in lower revenues from software licenses, software services, appraisal services, and other revenues. Lower software licenses compared to prior periods are attributed to slower sales cycles as government procurement processes are delayed and contract signings have been pushed to future periods. Software services and appraisal services revenue declines are attributed to delays in implementations caused by travel restrictions and shelter-in-place orders in effect during the period. Other revenues were lower compared to prior periods primarily as a result of the cancellation of our 2020 Connect user conference. Lower revenues compared to prior periods were offset by cost savings attributed to lower spend on travel, user conferences and trade show expenses, health claims and other employee-related expenses. If and as travel restrictions are relaxed, we expect software services and appraisal services revenues to increase as the limited number of our clients who require that all or a portion of their services be delivered onsite will be able to receive those services. Also, we are adapting by changing the way we do business, encouraging web and video conferencing, conducting virtual sales demonstrations and delivering professional services remotely, which result in increases in staff utilization rates and billable time. Recurring revenues from subscriptions and maintenance comprised 73.3% of our total consolidated revenue for the twelve months ended December 31, 2020, and include transaction-based revenue streams such as e-filing and online payments. As of December 31, 2020, we had $758.5 million in cash and investments and no outstanding borrowings under our credit facility. We also have substantial additional liquidity available through our undrawn $400 million credit facility, which can be expanded through an accordion feature. During the second quarter of 2020, we completed our annual assessment of goodwill which did not result in an impairment charge. Since our assessment in the second quarter of 2020, we have recorded no impairment to goodwill as no triggering events or changes in circumstances occurred as of period-end. No impairments of other assets were recorded as of the balance sheet date as no triggering events or changes in circumstances indicating a potential impairment have occurred as of period-end to require such an impairment; however, due to significant uncertainty surrounding the pandemic and market conditions, management’s judgment regarding this could change in the future. Security Incident On September 29, 2020, we filed a Current Report on Form 8-K reporting a security incident (the “Incident”) involving ransomware disrupting access to some of our internal IT systems and telephone systems. There is no evidence that the environments where we host client applications were affected, and our hosting services to those clients were not interrupted. There is also no evidence of malicious activity on client networks associated with the Incident. We contained the Incident and recovered from it, resuming normal operations with our clients. We will continue to deploy supplemental remediation efforts as necessary. As part of our immediate response to the Incident, we (1) shut down points of access to external systems and began investigating and remediating the problem; (2) engaged outside IT security and forensics experts to conduct a detailed review and help securely restore affected systems; (3) implemented targeted monitoring systems to supplement the systems we already had in place; and (4) notified law enforcement. We are have cooperated with their investigation throughout. 3 8 \ / 3 9 TYLER TECHNOLOGIES ANNUAL REPORT 2020 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Management’s Discussion and Analysis of Financial Condition and Results of Operations Management’s Discussion and Analysis of Financial Condition and Results of Operations We promptly notified our clients of the Incident and provided timely updates to our clients through direct communications and updates to our website. Although we believe we have contained and recovered from the Incident, and that we have taken and will continue to take appropriate remediation steps, we are subject to risk and uncertainties as a result of the Incident. We believe we are in the final phases of our investigation, but there can be no assurance as to what the ongoing impact of the Incident will be, if any. The Incident caused an interruption in parts of our business. We estimate that as a result of the Incident, revenue (primarily software services) for the year ended December 31, 2020 was reduced by approximately $1.5 million; however, insurance reimbursements pertaining to lost revenue represent a contingent gain and any recovery of these revenues will be recorded when received. We incurred $4.2 million in costs associated with the Incident as of December 31, 2020. As of December 31, 2020, we have recorded $1.1 million of accrued insurance recoveries and received $2.4 million of insurance recoveries related to the Incident. The recorded costs consisted primarily of payments to third-party service providers and consultants, including legal fees, and enhancements to our cybersecurity measures. It is expected that we will continue to incur costs related to our response, remediation, and investigatory efforts relating to the Incident. We maintain cybersecurity insurance coverage in an amount that we believe is adequate. Recent adoption of new accounting pronouncements In June 2016, the FASB issued ASU 2016-13, Financial Instruments — Credit Losses, (“ASU 2016-13”). ASU 2016-13 changes the impairment model for most financial assets and certain other instruments, including trade and other receivables, available for-sale debt securities, held-to- maturity debt securities and loans, and requires entities to use a new forward-looking expected loss model that will result in the earlier recognition of an allowance for losses. This update is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for a fiscal year beginning after December 15, 2018, including interim periods within that fiscal year. Entities apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. As of January 1, 2020, we adopted the new standard with no material impact of credit losses to our trade and other receivables, held-to-maturity debt securities and retained earnings included in our consolidated financial statements. On January 26, 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for Goodwill Impairment. The new standard eliminates Step 2 from the goodwill impairment test. An entity should recognize a goodwill impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. This standard is effective for public business entities in fiscal years beginning after December 15, 2019, and the standard was adopted and applied prospectively by the Company as of January 1, 2020, but it did not have a significant impact on the Company’s financial statements and disclosures. Recent Accounting Guidance not yet Adopted In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes, (“ASU 2019-12”) which simplifies the accounting for income taxes, eliminates certain exceptions within ASC 740, Income Taxes, and clarifies certain aspects of the current guidance to promote consistency among reporting entities. The new standard is effective for fiscal years beginning after December 15, 2020. Most amendments within the standard are required to be applied on a prospective basis, while certain amendments must be applied on a retrospective or modified retrospective basis. We do not expect adoption of this standard to have a material effect on our consolidated financial statements. Outlook The local government software market continues to be active, and our backlog at December 31, 2020 reached $1.59 billion, a 9.4% increase from the prior year. We expect to continue to achieve solid growth in revenue and earnings. With our strong financial position and cash flow, we plan to continue to make significant investments in product development to better position us to continue to expand our addressable market and strengthen our competitive position in the public sector software market over the long term. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our discussion and analysis of financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements, the reported amounts of revenues, cost of revenues and expenses during the reporting period, and related disclosure of contingencies. The Notes to the Financial Statements included as part of this Annual Report describe our significant accounting policies used in the preparation of the financial statements. Significant items subject to such estimates and assumptions include the application of the progress toward completion methods of revenue recognition, estimated standalone selling price (“SSP”) for distinct performance obligations, the carrying amount and estimated useful lives of intangible assets, determination of share-based compensation expense and valuation allowance for receivables. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies require significant judgments and estimates used in the preparation of our financial statements. Revenue Recognition. We earn revenue from software licenses, royalties, subscription-based services, software services, post-contract customer support (“PCS” or “maintenance”), hardware, and appraisal services. Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We determine revenue recognition through the following steps: Identification of the contract, or contracts, with a customer Identification of the performance obligations in the contract • • • Determination of the transaction price • Allocation of the transaction price to the performance obligations in the contract • Recognition of revenue when, or as, we satisfy a performance obligation Most of our software arrangements with customers contain multiple performance obligations that range from software licenses, installation, training, and consulting to software modification and customization to meet specific customer needs (services), hosting, and PCS. For these contracts, we account for individual performance obligations separately when they are distinct. We evaluate whether separate performance obligations can be distinct or should be accounted for as one performance obligation. Arrangements that include software services, such as training or installation, are evaluated to determine whether the customer can benefit from the services either on their own or together with other resources readily available to the customer and whether the services are separately identifiable from other promises in the contract. Many of our software arrangements involve “off-the-shelf” software. We recognize the revenue allocable to “off-the-shelf” software licenses and specified upgrades at a point in time when control of the software license transfers to the customer, unless the software is not considered distinct. We consider off-the-shelf software to be distinct when it can be added to an arrangement with minor changes in the underlying code, it can be used by the customer for the customer’s purpose upon installation, and remaining services such as training are not considered highly interdependent or highly interrelated to the product’s functionality. For arrangements that involve significant production, modification or customization of the software, or where software services are otherwise not considered distinct, we recognize revenue over time by measuring progress-to-completion. We measure progress-to-completion primarily using labor hours incurred as it best depicts the transfer of control to the customer which occurs as we incur costs on our contracts. These arrangements are often implemented over an extended period and occasionally require us to revise total cost estimates. Amounts recognized in revenue are calculated using the progress-to-completion measurement after giving effect to any changes in our cost estimates. Changes to total estimated contract costs, if any, are recorded in the period they are determined. Estimated losses on uncompleted contracts are recorded in the period in which we first determine that a loss is apparent. When software services are distinct, the fee allocable to the service element is recognized over the time we perform the services and is billed on a time and material or milestones basis. 4 0 \ / 4 1 TYLER TECHNOLOGIES ANNUAL REPORT 2020 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Management’s Discussion and Analysis of Financial Condition and Results of Operations Management’s Discussion and Analysis of Financial Condition and Results of Operations Subscription-based services consist of revenues derived from SaaS arrangements, which primarily utilize the Tyler private cloud, and electronic filing transactions. Revenue from subscription-based services is generally recognized over time on a ratable basis over the contract term, beginning on the date that our service is made available to the customer. For SaaS arrangements, we evaluate whether the customer has the contractual right to take possession of our software at any time during the hosting period without significant penalty and whether the customer can feasibly maintain the software on the customer’s hardware or enter into another arrangement with a third-party to host the software. We allocate contract value to each performance obligation of the arrangement that qualifies for treatment as a distinct element based on estimated SSP. We recognize SaaS arrangements ratably over the term of the arrangement, which range from one to ten years, but are typically for a period of three to five years. For software services associated with certain SaaS arrangements, we have concluded that the services are not distinct, and we recognize the revenue ratably over the remaining contractual period once we have provided the customer access to the software. We record amounts that have been invoiced in accounts receivable and in deferred revenue or revenues, depending on whether the revenue recognition criteria have been met. The transaction price is allocated to the separate performance obligations on a relative SSP basis. We determine the SSP based on our overall pricing objectives, taking into consideration market conditions and other factors, including the value of our contracts, the applications sold, customer demographics, and the number and types of users within our contracts. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine SSP using the expected cost-plus margin approach. Revenue is recognized net of allowances for sales adjustments and any taxes collected from customers, which are subsequently remitted to governmental authorities. Typically, the structure of our arrangements does not give rise to variable consideration. However, in those instances whereby variable consideration exists, we include in our estimates additional revenue for variable consideration when we believe we have an enforceable right, the amount can be estimated reliably and its realization is probable. We maintain allowances for losses and sales adjustments, which are provided at the time the revenue is recognized. Since most of our customers are domestic governmental entities, we rarely incur a loss resulting from credit risk associated with the inability of a customer to make required payments. Events or changes in circumstances that indicate that the carrying amount for the allowances for losses and sales adjustments may require revision include, but are not limited to, deterioration of a customer’s financial condition, failure to manage our customer’s expectations regarding the scope of the services to be delivered, and defects or errors in new versions or enhancements of our software products. The allowance for losses and sales adjustments reflects our best estimate of probable losses inherent in the accounts receivable balance. We determine the allowance based on known troubled accounts, historical experience, and other currently available evidence. Our allowance for losses and sales adjustments of $9.3 million and $5.7 million at December 31, 2020, and December 31, 2019, respectively, does not include provisions for credit losses. As of January 1, 2020, we adopted ASU 2016-13 and primarily evaluated our historical experience with credit losses related to trade and other receivables. Because we have not experienced any historical credit losses with the majority of our clients, we have no basis to record a reserve for credit losses as defined by the standard. In connection with certain of our contracts, we have recorded retentions receivable or unbilled receivables consisting of costs and estimated profit in excess of billings as of the balance sheet date. Many of the contracts which give rise to unbilled receivables at a given balance sheet date are subject to billings in the subsequent accounting period. We review unbilled receivables and related contract provisions to ensure we are justified in recognizing revenue prior to billing the customer and that we have objective evidence which allows us to recognize such revenue. In addition, we have a sizable amount of deferred revenue, which represents billings in excess of revenue earned. The majority of this liability consists of maintenance billings for which payments are made in advance and the revenue is ratably earned over the maintenance period, generally one year. We also have deferred revenue for those contracts in which we receive a deposit and the conditions in which to record revenue for the service or product have not been met. On a periodic basis, we review by customer the detail components of our deferred revenue to ensure our accounting remains appropriate. Intangible Assets and Goodwill. Our business acquisitions typically result in the creation of goodwill and other intangible asset balances, and these balances affect the amount and timing of future period amortization expense, as well as expense we could possibly incur as a result of an impairment charge. The cost of acquired companies is allocated to identifiable tangible and intangible assets based on estimated fair value, with the excess allocated to goodwill. Accordingly, we have a significant balance of acquisition date intangible assets, including software, customer related intangibles, trade name, leases and goodwill. These intangible assets (other than goodwill) are amortized over their estimated useful lives. We currently have no intangible assets with indefinite lives other than goodwill. We assess goodwill for impairment annually as of April 1st, or more frequently whenever events or changes in circumstances indicate its carrying value may not be recoverable. We begin with the qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying value before applying the quantitative assessment described below. When testing goodwill for impairment quantitatively, we first compare the fair value of each reporting unit with its carrying amount. If the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized. The fair values calculated in our impairment tests are determined using discounted cash flow models involving several assumptions. The assumptions that are used are based upon what we believe a hypothetical marketplace participant would use in estimating fair value. We base our fair value estimates on assumptions we believe to be reasonable but that are unpredictable and inherently uncertain. We evaluate the reasonableness of the fair value calculations of our reporting units by comparing the total of the fair value of all of our reporting units to our total market capitalization. During the second quarter, as part of our annual impairment test, we performed qualitative assessments for all reporting units except for the data and insights reporting unit. As a result of these qualitative assessments, we determined that it was not more likely than not that an impairment existed; therefore, we did not perform a Step 1 quantitative impairment test. We did perform a quantitative assessment for goodwill of $75.7 million associated with our data and insights business unit and concluded no impairment existed as of our annual assessment date. For most of our reporting units, goodwill relates to a combination of legacy and acquired businesses and as a result those units have fair values that substantially exceed their underlying carrying values. For other reporting units, in particular our platform technologies and data and insights business units, goodwill entirely relates to recently acquired businesses, and as a result those units do not have significant excess fair values over carrying values. The platform technologies and data and insights business units combined goodwill was $152.0 million, or 18%, of total goodwill as of December 31, 2020. Our annual goodwill impairment analysis did not result in an impairment charge. During 2020, we have recorded no impairment to goodwill as no triggering events or changes in circumstances indicating a potential impairment have occurred as of period-end. Determining the fair value of our reporting units involves the use of significant estimates and assumptions and considerable management judgment. We base our fair value estimates on assumptions we believe to be reasonable at the time, but such assumptions are subject to inherent uncertainty. Changes in market conditions or other factors outside of our control, such as the COVID-19 pandemic, could cause us to change key assumptions and our judgment about a reporting unit’s prospects. Similarly, in a specific period, a reporting unit could significantly underperform relative to its historical or projected future operating results. Either situation could result in a meaningfully different estimate of the fair value of our reporting units, and a consequent future impairment charge. All intangible assets (other than goodwill) are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of other intangible assets is measured by comparison of the carrying amount to estimated undiscounted future cash flows. The assessment of recoverability or of the estimated useful life for amortization purposes will be affected if the timing or the amount of estimated future operating cash flows is not achieved. Such indicators may include, among others: a significant decline in expected future cash flows; a sustained, significant decline in stock price and market capitalization; a significant adverse change in legal factors or in the business climate; unanticipated competition; and reductions in growth rates. In addition, products, capabilities, or technologies developed by others may render our software products obsolete or non-competitive. Any adverse change in these factors could have a significant impact on the recoverability of goodwill or other intangible assets. During 2020, we did not identify any triggering events that would indicate that the carrying amount of our intangible assets may not be recoverable. 4 2 \ / 4 3 TYLER TECHNOLOGIES ANNUAL REPORT 2020 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Management’s Discussion and Analysis of Financial Condition and Results of Operations Management’s Discussion and Analysis of Financial Condition and Results of Operations Share-Based Compensation. We have a stock incentive plan that provides for the grant of stock options, restricted stock units and performance stock units to key employees, directors and non-employee consultants. We estimate the fair value of share-based awards on the date of grant. Share-based compensation expense includes the estimated effects of forfeitures, which will be adjusted over the requisite service period to the extent actual forfeitures differ or are expected to differ from such estimates. Changes in estimated forfeitures are recognized in the period of change and will also impact the amount of expense to be recognized in future periods. Forfeiture rate assumptions are derived from historical data. We estimate stock price volatility at the date of grant based on the historical volatility of our common stock. Estimated option life is determined using the weighted-average period the stock options are expected to be outstanding based primarily on the options’ vesting terms, remaining contractual life and the employees’ expected exercise based on historical patterns. Determining the appropriate fair-value model and calculating the fair value of share-based awards at the grant date requires considerable judgment, including estimating stock price volatility, expected option life and forfeiture rates. ANALYSIS OF RESULTS OF OPERATIONS AND OTHER The following discussion compares the historical results of operations on a basis consistent with GAAP for the years ended December 31, 2020, 2019 and 2018. Percentage of Total Revenues 2020 Compared to 2019 Revenues On February 28, 2019, we acquired all of the capital stock of MicroPact, a leading provider of COTS solutions, including entellitrak®, a low-code application development platform for case management and business process management used extensively in the public sector. The following table details revenue for MicroPact for the periods presented as of December 31, 2020 and 2019, which is included in our consolidated statements of income from the date of acquisition: Revenues: Software licenses and royalties Subscriptions Software services Maintenance Appraisal services Hardware and other Total revenues 2020 2019 $ 5,206 10,823 21,391 39,701 — 36 $ 77,157 $ 8,737 7,472 18,143 28,642 — 24 $ 63,018 Years Ended December 31, Revenues: Software licenses and royalties Subscriptions Software services Maintenance Appraisal services Hardware and other Total revenues Operating expenses: Cost of software licenses, royalties and acquired software Cost of subscriptions, software services and maintenance Cost of appraisal services Cost of hardware and other Selling, general and administrative expenses Research and development expense Amortization of customer and trade name intangibles Operating income Other income, net Income before income taxes Income tax (benefit) provision Net income 2020 2019 2018 Software licenses and royalties. The following table sets forth a comparison of our software licenses and royalties revenue for the years ended December 31: 6.5% 31.4 16.7 41.9 1.9 1.6 100.0 9.2% 27.3 19.6 39.6 2.2 2.1 100.0 10.0% 23.6 20.5 41.1 2.3 2.5 100.0 3.2 45.8 1.4 1.1 23.2 7.9 1.9 15.5 0.2 15.7 (1.8) 17.5% 3.2 46.2 1.4 1.6 23.7 7.5 2.0 14.4 0.3 14.7 1.2 13.5% 2.9 46.9 1.5 1.7 22.2 6.8 1.7 16.3 0.4 16.7 0.9 15.8% ($ in thousands) ES A&T Total software licenses and royalties revenue Change 2020 2019 $ $ 64,200 8,964 $ 73,164 $ 90,808 9,397 $ 100,205 $ (26,608) (433) $ (27,041) % (29)% (5) (27)% Software licenses and royalties revenue decreased 27% compared to the prior year. The decline is primarily due to longer sales cycles attributed to our ERP, public safety, and appraisal software products as the impact of COVID-19 has slowed government procurement processes and some contract signings have been pushed to future periods. Software licenses revenue was also negatively impacted by delayed deliveries attributed to the IT security incident that occurred in late September 2020. Also contributing to the decline is the shift in the mix of new software contracts toward more subscription-based agreements compared to the prior year. Our total new client mix in 2020 was approximately 38% perpetual software license arrangements and approximately 62% subscription-based arrangements compared to total new client mix in 2019 of approximately 46% perpetual software license arrangements and approximately 54% subscription-based arrangements. Although the mix of new contracts between subscription-based and perpetual license arrangements may vary from quarter to quarter and year to year, we expect our longer-term software license growth rate to be negatively impacted by a growing number of customers choosing our subscription-based options, rather than purchasing the software under a traditional perpetual software license arrangement. Subscription- based arrangements result in lower software license revenue in the initial year as compared to perpetual software license arrangements but generate higher overall revenue over the term of the contract. 4 4 \ / 4 5 TYLER TECHNOLOGIES ANNUAL REPORT 2020 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Management’s Discussion and Analysis of Financial Condition and Results of Operations Management’s Discussion and Analysis of Financial Condition and Results of Operations Subscriptions. Maintenance. The following table sets forth a comparison of our subscriptions revenue for the years ended December 31: The following table sets forth a comparison of our maintenance revenue for the years ended December 31: ($ in thousands) ES A&T Total subscriptions revenue Change 2020 2019 $ $ 326,284 24,364 $ 350,648 $ 279,282 17,070 $ 296,352 $ 47,002 7,294 $ 54,296 % 17% 43 18% ($ in thousands) ES A&T Total maintenance revenue Change 2020 2019 $ $ 429,224 38,289 $ 467,513 $ 393,521 36,797 $ 430,318 $ 35,703 1,492 $ 37,195 % 9% 4 9% Subscription-based revenue primarily consists of revenue derived from our SaaS arrangements, which generally utilize the Tyler private cloud. As part of our subscription-based services, we also provide electronic document filing solutions (“e-filing”) that simplify the filing and management of court related documents for courts and law offices. E-filing revenue is derived from transaction fees and fixed fee arrangements. Subscription-based revenue increased 18% compared to 2019. New SaaS clients as well as existing clients who converted to our SaaS model provided the majority of the subscription revenue increase. In 2020, we added 488 new SaaS clients and 157 existing clients elected to convert to our SaaS model. Also, transaction-based fees contributed $7.7 million to the increase in subscription revenue due to the increased volumes of online payments from utility billings and slightly increased e-filing services volumes in 2020. Software services. The following table sets forth a comparison of our software services revenue for the years ended December 31: ($ in thousands) ES A&T Total software services revenue Change 2020 2019 $ $ 164,520 21,889 $ 186,409 $ 179,865 33,196 $ 213,061 $ (15,345) (11,307) $ (26,652) % (9)% (34) (13)% Software services revenue primarily consists of professional services billed in connection with implementing our software, converting client data, training client personnel, custom development activities and consulting. New clients who purchase our proprietary software licenses or subscriptions generally also contract with us to provide for the related software services. Existing clients also periodically purchase additional training, consulting and minor programming services. Software services revenue decreased 13% compared to the prior year period. The decline in software services is due to delays in client implementations caused by COVID-19 travel restrictions and shelter-in-place orders and a decline in billable travel revenue, as most services are now being delivered virtually rather than on-site. Software services revenue was also lower due to interruptions caused by the IT security incident that occurred in late September 2020. We estimate that as a result of the Incident, revenue (primarily software services) was reduced by approximately $1.5 million in 2020; however, insurance reimbursements pertaining to lost revenue represent a contingent gain and any recovery of these revenues will be recorded when received. Also contributing to the decline is the increase of clients selecting our cloud solutions instead of our on-premises license arrangements which typically require more professional services. 4 6 \ We provide maintenance and support services for our software products and certain third-party software. Maintenance revenue grew 9% compared to the prior year. Maintenance revenue increased mainly due to contributions of maintenance revenue from recent acquisitions and completing the recognition of the majority of acquisition-related deferred maintenance revenue that was fair valued at rates below Tyler’s average maintenance rate in prior periods. The remainder of the increase is attributed to annual maintenance rate increases and growth in our installed customer base from new software license sales, partially offset by attrition and clients converting from on-premises license arrangements to SaaS. Appraisal services. The following table sets forth a comparison of our appraisal services revenue for the years ended December 31: ($ in thousands) ES A&T Total appraisal services revenue Change 2020 2019 $ % $ — 21,127 $ 21,127 $ — 23,479 $ 23,479 $ — (2,352) $ (2,352) —% (10) (10)% In 2020, appraisal services revenue decreased 10% compared to the prior year primarily due to the delays to several ongoing projects as a result of travel restrictions and shelter-in-place orders related to COVID-19. The appraisal services business is somewhat cyclical and driven in part by statutory revaluation cycles in various states. Cost of Revenues and Gross Margins The following table sets forth a comparison of the key components of our cost of revenues for the years ended December 31: ($ in thousands) 2020 2019 $ Change Software licenses and royalties Acquired software Subscriptions, software services and maintenance Appraisal services Hardware and other Total cost of revenues $ 3,339 31,962 510,504 15,945 12,401 $ 574,151 $ 3,938 30,642 502,138 15,337 17,472 $ 569,527 $ (599) 1,320 8,366 608 (5,071) $ 4,624 % (15)% 4 2 4 (29) 1% / 4 7 TYLER TECHNOLOGIES ANNUAL REPORT 2020 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Management’s Discussion and Analysis of Financial Condition and Results of Operations Management’s Discussion and Analysis of Financial Condition and Results of Operations The following table sets forth a comparison of gross margin percentage by revenue type for the years ended December 31: Selling, General and Administrative Expenses Gross margin percentage Software licenses, royalties and acquired software Subscriptions, software services and maintenance Appraisal services Hardware and other Overall gross margin 2020 51.8% 49.2 24.5 30.3 48.6% 2019 Change 65.5% 46.6 34.7 24.1 47.6% (13.7)% 2.6 (10.2) 6.2 1.0% Software licenses, royalties and acquired software. Cost of software licenses, royalties and acquired software is primarily comprised of amortization expense for acquired software and third-party software costs. We do not have any direct costs associated with royalties. The gross margin decrease of 13.7% is due to lower revenue from software licenses compared to the prior period. Subscriptions, software services and maintenance. Cost of subscriptions, software services and maintenance primarily consists of personnel costs related to installation of our software, conversion of client data, training client personnel and support activities and various other services such as custom client development and on-going operation of SaaS and e-filing arrangements. In 2020, the subscriptions, software services and maintenance gross margin increased 2.6% compared to the prior year. Margins have increased primarily due to a reduction in software services revenues from reimbursable travel that has little to no margin, as well as improved utilization of our professional services staff resulting from the shift to virtual delivery of most implementation services, offset somewhat by the reduction in software services revenues as a result of the Incident in late September 2020. Our implementation and support staff grew by 131 employees since December 31, 2019, as we increased hiring to ensure that we are well-positioned to deliver our current backlog and anticipated new business. Costs related to maintenance and various other services such as SaaS and e-filing typically grow at a slower rate than related revenue due to leverage in the utilization of support and maintenance staff and economies of scale. Appraisal services. Appraisal services revenue comprised approximately 1.9% of total revenue. The appraisal services gross margin decreased 10.2% compared to 2019 due to lower staff utilization as a result of COVID-19 travel restrictions and shelter-in-place orders in place during the current period. The appraisal services business is somewhat cyclical and driven in part by statutory revaluation cycles in various states. Our 2020 blended gross margin increased 1.0% compared to 2019. The slight increase in overall gross margin is attributed to a higher revenue mix for subscription revenues compared to the prior year periods resulting in an increase in incremental margin related to subscriptions, software services and maintenance. Margins have also increased due a reduction in software services revenue from reimbursable travel that has little to no margin, as well as improved utilization of our professional services staff resulting from the shift to virtual delivery of most implementation services, offset somewhat by the reduction in software services revenues as a result of the Incident in late September 2020. Costs related to maintenance and various other services such as SaaS and e-filing typically grow at a slower rate than related revenue due to leveraging utilization of support and maintenance staff and economies of scale. In addition, the cancellation of our Connect user conference scheduled for April 2020 and the related elimination of approximately $6 million of revenues with no associated margin also had a positive impact on our overall gross margin. These increases in overall gross margins are partially offset by lower margins from software licenses due to lower software license revenue as well as lower staffing utilization attributable to appraisal services. Selling, general and administrative (“SG&A”) expenses consist primarily of salaries, employee benefits, travel, share-based compensation expense, commissions and related overhead costs for administrative and sales and marketing employees, as well as, professional fees, trade show activities, advertising costs and other marketing related costs. The following table sets forth a comparison of our SG&A expenses for the years ended December 31: ($ in thousands) 2020 2019 $ Selling, general and administrative expenses $ 259,561 $ 257,746 $ 1,815 Change % 1% SG&A as a percentage of revenue was 23.2% in 2020 compared to 23.7% in 2019. SG&A expense increased approximately 1% compared to the prior year period. The increase in SG&A expense is attributed to increased stock compensation expense compared to the prior period. During 2020, stock compensation expense rose $4.3 million compared to 2019, primarily due to an increase in share-based awards issued in connection with our stock compensation plan coupled with the higher fair value of each share-based award due to the increase in our stock price. These increases in SG&A were offset by lower bonus and commission expense as a result of lower sales, lower travel expenses associated with sales and marketing activities, including trade shows, as a result of COVID-19 travel restrictions, and lower health claim expenses during the current period. Research and Development Expense Research and development expense consists primarily of salaries, employee benefits and related overhead costs associated with new product development. The following table sets forth a comparison of our research and development expense for the years ended December 31: ($ in thousands) 2020 2019 $ Research and development expense $ 88,363 $ 81,342 $ 7,021 Change % 9% Research and development expense consists mainly of costs associated with development of new products and technologies from which we do not currently generate significant revenue. Research and development expense increased 9% in 2020 compared to the prior year period, mainly due to a number of new Tyler product development initiatives across our product suites, including increased investments in research and development at recently acquired businesses. To support these initiatives, our research and development staff grew by 38 since December 31, 2019. Amortization of Customer and Trade Name Intangibles Acquisition intangibles are comprised of the excess of the purchase price over the fair value of net tangible assets acquired that is allocated to acquired software, leases and customer and trade name intangibles. The remaining excess purchase price is allocated to goodwill that is not subject to amortization. Amortization expense related to acquired software is included with cost of revenues, while amortization expense of customer and trade name intangibles is recorded as operating expense. The estimated useful lives of both customer and trade name intangibles range from five to 25 years. The following table sets forth a comparison of amortization of customer and trade name intangibles for the years ended December 31: ($ in thousands) Amortization of customer and trade name intangibles 2020 2019 $ 21,662 $ 21,445 Change $ $ 217 % 1% Amortization of customer and trade name intangibles increased due to the impact of intangibles added with several acquisitions completed in 2019. 4 8 \ / 4 9 TYLER TECHNOLOGIES ANNUAL REPORT 2020 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Management’s Discussion and Analysis of Financial Condition and Results of Operations Management’s Discussion and Analysis of Financial Condition and Results of Operations Estimated annual amortization expense relating to customer and trade name acquisition intangibles, excluding acquired software for which the amortization expense is recorded as cost of revenues, for the next five years and thereafter is as follows (in thousands): 2021 2022 2023 2024 2025 Thereafter $ 21,317 20,827 20,753 20,201 19,672 116,779 The most significant provision of the CARES Act impacting our accounting for income taxes is the five-year carryback allowance for taxable net operating losses generated in tax years in which the statutory federal income tax rate is 21.0% to periods in which the statutory federal income tax rate is 35.0%. We intend to carry back our 2020 taxable loss into our 2015 tax year, which results in a $3.4 million income tax benefit in the current year. The effective income tax rates in both 2020 and 2019 differed from the United States federal statutory corporate income tax rate of 21% primarily due to state income taxes, the research tax credit, non-deductible share-based compensation expense, disqualifying incentive stock award dispositions, and other non-deductible business expenses. The 2020 effective income tax rate also includes the tax benefit of the five- year carryback of the federal net operating loss allowed under the CARES Act. Amortization expense relating to acquired leases will be recorded as a reduction to hardware and other revenue and is expected to be $525,000 in 2021, $525,000 in 2022, $525,000 in 2023, $525,000 in 2024, $397,000 in 2025, and $114,000 thereafter. FINANCIAL CONDITION AND LIQUIDITY Other The following table sets forth a comparison of other income, net for the years ended December 31: ($ in thousands) Other income, net Change 2020 2019 $ % $ 2,116 $ 3,471 $ (1,355) (39)% Other income is comprised of interest income from invested cash net of interest expense and non-usage and other fees associated with our revolving credit agreement. The decrease in other income, net compared to the prior period is attributable to the significant decrease in interest rates on cash balances since March 2020, partially offset by higher levels of invested cash. Income Tax Provision The following table sets forth a comparison of our income tax provision for the years ended December 31: ($ in thousands) Income tax (benefit) provision Effective income tax rate Change 2020 2019 $ % $ (19,778) $ 13,311 $ (33,089) (249)% (11.3)% 8.3% The decrease in the income tax provision and the effective income tax rate in 2020 compared to the prior year is primarily due to higher excess tax benefits of share-based compensation in 2020. The share-based exercise and vesting activity in 2020 generated excess tax benefits of $60.2 million, while exercise and vesting activity in 2019 generated $29.8 million of excess tax benefits. Excluding the impact of the excess tax benefits, our income tax provision and effective tax rate in 2020 would have been $40.4 million and 23.1% and in 2019, would have been $43.1 million and 27.0%, respectively. The Coronavirus Aid, Relief and Economic Security (“CARES”) Act, which was signed into law on March 27, 2020, provides an estimated $2.2 trillion to fight the COVID-19 pandemic and stimulate the U.S. economy. The assistance includes tax relief and government loans, and investments and grants for entities in affected industries (e.g., health care, airlines). The business tax provisions of the CARES Act include temporary changes to income and non-income based tax laws, including the ability to utilize net operating losses, interest expense deductions, alternative minimum tax credit refunds, charitable contributions, and depreciation of qualified improvement property. Measures not related to income-based taxes include (1) allowing an employer to pay its share of Social Security payroll taxes that would otherwise be due from the date of enactment through December 31, 2020, over the following two years and (2) allowing eligible employers subject to closure due to the COVID-19 pandemic to receive a 50% credit on qualified wages against their employment taxes each quarter, with any excess credits eligible for refunds. As of December 31, 2020, we had cash and cash equivalents of $603.6 million compared to $232.7 million at December 31, 2019. We also had $154.8 million invested in investment grade corporate bonds, municipal bonds and asset-backed securities as of December 31, 2020, compared to $81.6 million at December 31, 2019. These investments mature from 2021 through 2028 and we intend to hold these investments until maturity. Cash and cash equivalents consist of cash on deposit with several domestic banks and money market funds. As of December 31, 2020, we had no outstanding borrowings and one outstanding letter of credit totaling $2.0 million in favor of a client contract. We believe our revolving line of credit, cash from operating activities, cash on hand and access to the credit markets provide us with sufficient flexibility to meet our long-term financial needs. The following table sets forth a summary of cash flows for the years ended December 31: ($ in thousands) 2020 2019 Change Cash flows provided (used) by: Operating activities Investing activities Financing activities Net increase (decrease) in cash and cash equivalents $ 355,089 (98,320) 114,172 $ 370,941 $ 254,720 (245,015) 88,698 $ 98,403 $ 250,203 (238,255) (63,595) $ (51,647) Net cash provided by operating activities continues to be our primary source of funds to finance operating needs and capital expenditures. Other potential capital resources include cash on hand, public and private issuances of debt or equity securities, and bank borrowings. It is possible that our ability to access the capital and credit markets in the future may be limited by economic conditions or other factors. We currently believe that cash provided by operating activities, cash on hand and available credit are sufficient to fund our working capital requirements, capital expenditures, income tax obligations, and share repurchases for at least the next twelve months. In 2020, operating activities provided cash of $355.1 million compared to $254.7 million in 2019. Operating activities that provided cash were primarily comprised of net income of $194.8 million, non-cash depreciation and amortization charges of $81.7 million, non-cash share-based compensation expense of $67.4 million and non-cash decrease in operating lease right-of-use assets of $5.8 million. Working capital, excluding cash, decreased approximately $1.9 million due to higher accounts receivable resulting from an increase in unbilled receivables attributed to revenues recognized prior to billings, higher accounts receivable related to annual maintenance and subscription billings, timing of income tax payments, and the deferred taxes associated with stock option activity during the period. These increases were offset by the growth in deferred revenue balances and timing of payments of payroll related taxes and vendor invoices. In general, changes in the balance of deferred revenue are cyclical and primarily driven by the timing of our maintenance and subscription billings. Our renewal dates occur throughout the year, but our largest maintenance renewal cycles occur in the second and fourth quarters. 5 0 \ / 5 1 TYLER TECHNOLOGIES ANNUAL REPORT 2020 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Management’s Discussion and Analysis of Financial Condition and Results of Operations Management’s Discussion and Analysis of Financial Condition and Results of Operations Days sales outstanding in accounts receivable were 121 days at December 31, 2020, compared to 117 days at December 31, 2019. The increase in our DSO is mainly due to an increase in unbilled receivables attributed to the increase in software license revenue for which we have recognized revenue at the point in time when the software is made available to the customer, but the billing has not yet been submitted to the customer. An increase in software services contracts accounted for using progress-to-completion method of revenue recognition in which the services are performed in one accounting period, but the billing normally occurs subsequently in another accounting period also contributed to the increase in DSO. Furthermore, our maintenance billing cycle typically peaks at its highest level in June and second highest level in December of each year and is followed by collections in the subsequent quarter. DSO is calculated based on quarter-end accounts receivable (excluding long-term receivables but including unbilled receivables) divided by the quotient of annualized quarterly revenues divided by 360 days. Investing activities used cash of $98.3 million in 2020 compared to $245.0 million in 2019. We invested $156.6 million and received $82.7 million in proceeds from investment grade corporate bonds, municipal bonds and asset-backed securities with maturity dates ranging from 2021 through 2028. During 2020, we received $15.0 million in proceeds from the sale of the investment in convertible preferred stock representing a 20% interest in Record Holdings to BFTR, LLC, a wholly owned subsidiary of Bison Capital Partners V.L.P. During the same period, we purchased $10.0 million in common stock representing a 18% interest in BFTR, LLC. We paid $1.3 million in working capital and indemnity holdbacks in connection with the 2019 acquisition of Courthouse Technologies, Ltd. Approximately $22.7 million was invested in property and equipment, including $9.9 million related to real estate. In addition, approximately $5.8 million of software development was capitalized in 2020. The remaining additions were for computer equipment and furniture and fixtures in support of internal growth, particularly with respect to data centers supporting growth in our cloud-based offerings. These expenditures were funded from cash generated from operations. In 2019, we invested $54.7 million and received $70.8 million in proceeds from investment grade corporate bonds, municipal bonds and asset-backed securities with maturity dates ranging from 2020 through 2023. On February 28, 2019, we acquired all of the capital stock of MicroPact. The total purchase price, net of cash acquired of $2.0 million, was approximately $202.2 million, including $198.2 million paid in cash and accrued contingent consideration of $6.0 million at December 31, 2019. On February 1, 2019, we acquired all the assets of MyCivic for the total purchase price of $3.7 million paid in cash. On October 30, 2019, we acquired certain assets of CHT. The total purchase price was approximately $20.5 million of which $19.1 million was paid in cash and approximately $1.4 million accrued for working capital and indemnity holdbacks, subject to certain post-closing adjustments. Approximately $37.2 million was invested in property and equipment, including $20.8 million related to real estate. In addition, approximately $4.8 million of software development was capitalized in 2019. The remaining additions were for computer equipment and furniture and fixtures in support of internal growth, particularly with respect to data centers supporting growth in our cloud-based offerings. These expenditures were funded from cash generated from operations. Financing activities provided cash of $114.2 million in 2020 compared to $88.7 million in 2019. Financing activities in 2020 were primarily comprised of collections of $135.3 million from stock option exercises and employee stock purchase plan activity. We also purchased approximately 59,000 shares of our common stock for an aggregate purchase price of $15.5 million. Financing activities provided cash of $88.7 million in 2019 compared to cash used of $63.6 million in 2018. Financing activities in 2019 were primarily comprised of collections of $106.5 million from stock option exercises and employee stock purchase plan activity. We also purchased approximately 72,000 shares of our common stock for an aggregate purchase price of $14.3 million. In February 2019, our board of directors authorized the repurchase of an additional 1.5 million shares of Tyler common stock. The repurchase program, which was approved by our board of directors, was announced in October 2002, and was amended at various times from 2003 through 2019. As of February 19, 2021, we had remaining authorization to repurchase up to 2.5 million additional shares of our common stock. Our share repurchase program allows us to repurchase shares at our discretion. Market conditions influence the timing of the buybacks and the number of shares repurchased, as well as the volume of employee stock option exercises. Share repurchases are generally funded using our existing cash balances and borrowings under our credit facility and may occur through open market purchases and transactions structured through investment banking institutions, privately negotiated transactions and/or other mechanisms. There is no expiration date specified for the authorization and we intend to repurchase stock under the plan from time to time. On September 30, 2019, we entered into a $400.0 million credit agreement (the “Credit Facility”) with the various lenders party thereto and Wells Fargo Bank, National Association, as Administrative Agent. The Credit Facility provides for an unsecured revolving credit line of up to $400.0 million, including a $25.0 million sublimit for letters of credit. The Credit Facility matures on September 30, 2024. Borrowings under the Credit Facility may be used for general corporate purposes, including working capital requirements, acquisitions and share repurchases. Borrowings under the Credit Facility bear interest at a rate of either (1) Wells Fargo Bank’s prime rate (subject to certain higher rate determinations) plus a margin of 0.125% to 0.75% or (2) the 30, 60, 90 or 180 day LIBOR rate plus a margin of 1.125% to 1.75%. As of December 31, 2020, our interest rate was 3.38% under the prime rate option or approximately 1.27% under the 30-day LIBOR option. The Credit Facility is unsecured by substantially all of our assets. The Credit Facility requires us to maintain certain financial ratios and other financial conditions and prohibits us from making certain investments, advances, cash dividends or loans, and limits incurrence of additional indebtedness and liens. As of December 31, 2020, we were in compliance with those covenants. As of December 31, 2020, we had no outstanding borrowings and had unused borrowing capacity of $400.0 million under the Credit Facility. We paid interest of $610,000 in 2020, $1,750,000 in 2019, and $770,000 in 2018. We paid income taxes, net of refunds received, of $3.3 million in 2020, $21.3 million in 2019, and $6.8 million in 2018. In 2020, we experienced significant stock option exercise activity that generated net tax benefits of $60.2 million and reduced tax payments accordingly. In 2019 and 2018, excess tax benefits were $29.8 million and $32.5 million, respectively. We anticipate that 2021 capital spending will be between $39 million and $40 million, including approximately $3 million related to real estate and approximately $17 million of capitalized software development. We expect the majority of the other capital spending will consist of computer equipment and software for infrastructure replacements and expansion. Capital spending is expected to be funded from existing cash balances and cash flows from operations. From time to time we engage in discussions with potential acquisition candidates. In order to pursue such opportunities, which could require significant commitments of capital, we may be required to incur debt or to issue additional potentially dilutive securities in the future. No assurance can be given as to our future acquisition opportunities and how such opportunities will be financed. We lease office facilities for use in our operations, as well as transportation and other equipment. Most of our leases are non-cancelable operating lease agreements and they expire from one year to seven years. Some of these leases include options to extend for up to 10 years. CAPITALIZATION At December 31, 2020, our capitalization consisted of no outstanding debt and $2.0 billion of shareholders’ equity. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk represents the risk of loss that may affect us due to adverse changes in financial market prices and interest rates. As of December 31, 2020, our interest rate was 3.38% under the prime rate option or approximately 1.27% under the 30-day LIBOR option. Loans under the Credit Facility bear interest, at Tyler’s option, at a per annum rate of either (1) Wells Fargo Bank’s prime rate (subject to certain higher rate determinations) plus a margin of 0.125% to 0.75% or (2) the one-, two-, three-, or six-month LIBOR rate plus a margin of 1.125% to 1.75%. As of December 31, 2020, we had no outstanding borrowings under the Credit Facility and therefore are not subject to any interest risk. 5 2 \ / 5 3 TYLER TECHNOLOGIES ANNUAL REPORT 2020 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Management’s Discussion and Analysis of Financial Condition and Results of Operations Report of Independent Registered Public Accounting Firm CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures — We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act) designed to provide reasonable assurance that the information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. These include controls and procedures designed to ensure that this information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosures. Management, with the participation of the chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2020. Based on this evaluation, the chief executive officer and chief financial officer have concluded that our disclosure controls and procedures were effective as of December 31, 2020. Management’s Report on Internal Control Over Financial Reporting — Tyler’s management is responsible for establishing and maintaining effective internal control over financial reporting as defined in Securities Exchange Act Rule 13a-15(f). Tyler’s internal control over financial reporting is designed to provide reasonable assurance to Tyler’s management and board of directors regarding the preparation and fair presentation of published financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Management assessed the effectiveness of Tyler’s internal control over financial reporting as of December 31, 2020. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Based on our assessment, we concluded that, as of December 31, 2020, Tyler’s internal control over financial reporting was effective based on those criteria. Tyler’s internal control over financial reporting as of December 31, 2020 has been audited by Ernst & Young LLP, the independent registered public accounting firm who also audited Tyler’s financial statements. Ernst & Young’s attestation report on Tyler’s internal control over financial reporting appears on page 57 hereof. Changes in Internal Control Over Financial Reporting — During the quarter ended December 31, 2020, there were no changes in our internal control over financial reporting, as defined in Securities Exchange Act Rule 13a-15(f), that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. To the Shareholders and the Board of Directors of Tyler Technologies, Inc. Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Tyler Technologies, Inc. (the Company) as of December 31, 2020 and 2019, the related consolidated statements of comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 19, 2021 expressed an unqualified opinion thereon. Basis for Opinion These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the account or disclosure to which it relates. 5 4 \ / 5 5 TYLER TECHNOLOGIES ANNUAL REPORT 2020 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Report of Independent Registered Public Accounting Firm Report of Independent Registered Public Accounting Firm Estimation of hours for certain progress-to-completion (POC) arrangements To the Shareholders and the Board of Directors of Tyler Technologies, Inc. Description of the Matter Opinion on Internal Control over Financial Reporting As described in Note 1 to the consolidated financial statements under “Revenue Recognition,” many of the Company’s software arrangements involve “off-the-shelf” software. For arrangements that involve significant production, modification or customization of the software, or where software services are otherwise not considered distinct, the Company recognizes revenue over time based on a measurement of progress-to- completion (POC). The Company measures POC primarily using labor hours incurred, believing it best depicts the pattern of transfer of control to the customer, which occurs as the Company incurs costs on its contracts. Estimates of budgeted total hours for these arrangements requires management judgment. Auditing management’s estimates of total budgeted contract hours required additional audit effort due to the existence of management judgment required to make these estimates for arrangements that are completed over an extended period. These estimates require ongoing monitoring by management and may require revision over time. How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design, and tested the operating effectiveness of controls over the Company’s process to review contract progress-to-date and total budgeted hours, inclusive of executed contract amendments and change orders. To test the appropriateness of management’s assessment of contract progress-to-date, our audit procedures included, among others, obtaining an understanding of any increase or decrease to budgeted hours via contract amendments or change orders, observing quarterly POC meetings where the Company discussed contract progress-to-date and evaluated the appropriateness of contract estimated hours to complete, reviewing signed Company attestations as to the contracts’ progress toward completion, performing a sensitivity analysis to assess the appropriateness of remaining budgeted hours and trend of progress on the contracts and performing an analysis of completed contracts to compare actual hours incurred upon completion to the original budget. We have served as the Company’s auditor since 1966. Dallas, Texas February 19, 2021 We have audited Tyler Technologies, Inc.’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Tyler Technologies, Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), consolidated balance sheets of the Company as of December 31, 2020 and 2019, the related consolidated statements of comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and our report dated February 19, 2021 expressed an unqualified opinion thereon. Basis for Opinion The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Dallas, Texas February 19, 2021 5 6 \ / 5 7 TYLER TECHNOLOGIES ANNUAL REPORT 2020 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Consolidated Statements of Comprehensive Income Consolidated Balance Sheets For the years ended December 31, (In thousands, except per share amounts) Revenues: Software licenses and royalties Subscriptions Software services Maintenance Appraisal services Hardware and other Total revenues Cost of revenues: Software licenses and royalties Acquired software Subscriptions, software services and maintenance Appraisal services Hardware and other Total cost of revenues Gross profit Selling, general and administrative expenses Research and development expense Amortization of customer and trade name intangibles Operating income Other income, net Income before income taxes Income tax (benefit) provision Net income Earnings per common share: Basic Diluted See accompanying notes. 5 8 \ 2020 2019 2018 December 31, 2020 2019 $ 73,164 350,648 186,409 467,513 21,127 17,802 1,116,663 3,339 31,962 510,504 15,945 12,401 574,151 $ 100,205 296,352 213,061 430,318 23,479 23,012 1,086,427 3,938 30,642 502,138 15,337 17,472 569,527 $ 93,441 220,547 191,269 384,521 21,846 23,658 935,282 3,802 22,972 438,923 14,299 15,708 495,704 542,512 516,900 439,578 259,561 88,363 21,662 257,746 81,342 21,445 207,605 63,264 16,217 172,926 156,367 152,492 2,116 175,042 (19,778) $ 194,820 3,471 159,838 13,311 $ 146,527 3,378 155,870 8,408 $ 147,462 $ $ 4.87 4.69 $ $ 3.79 3.65 $ $ 3.84 3.68 (In thousands, except par value and share amounts) ASSETS Current assets: Cash and cash equivalents Accounts receivable (less allowance for losses and sales adjustments of $9,255 in 2020 and $5,738 in 2019) Short-term investments Prepaid expenses Income tax receivable Other current assets Total current assets Accounts receivable, long-term Operating lease right-of-use assets Property and equipment, net Other assets: Goodwill Other intangibles, net Non-current investments Other non-current assets LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities: Accounts payable Accrued liabilities Operating lease liabilities Deferred revenue Total current liabilities Revolving line of credit Deferred revenue, long-term Deferred income taxes Operating lease liabilities, long-term Commitments and contingencies Shareholders’ equity: Preferred stock, $10.00 par value; 1,000,000 shares authorized; none issued Common stock, $0.01 par value; 100,000,000 shares authorized; 48,147,969 shares issued in 2020 and 2019 Additional paid-in capital Accumulated other comprehensive loss, net of tax Retained earnings Treasury stock, at cost; 7,608,627 and 8,839,352 shares in 2020 and 2019, respectively Total shareholders’ equity See accompanying notes. $ 603,623 382,319 72,187 30,864 21,598 2,479 1,113,070 21,417 18,734 168,004 838,428 331,189 82,640 33,792 $ 2,607,274 $ 14,011 83,084 5,904 461,278 564,277 — 100 40,507 16,279 — — 481 905,332 (46) 1,112,156 (31,812) 1,986,111 $ 2,607,274 $ 232,682 374,089 39,399 24,717 6,482 2,328 679,697 22,432 18,992 171,861 840,117 378,914 42,235 37,366 $ 2,191,614 $ 14,977 75,234 6,387 412,495 509,093 — 199 48,442 16,822 — — 481 739,478 (46) 917,336 (40,191) 1,617,058 $ 2,191,614 / 5 9 TYLER TECHNOLOGIES ANNUAL REPORT 2020 TYLER TECHNOLOGIES ANNUAL REPORT 2020 Consolidated Statements of Cash Flows Consolidated Statements of Shareholders’ Equity For the years ended December 31, (In thousands) Cash flows from operating activities: Net income Adjustments to reconcile net income to cash provided by operations: Depreciation and amortization Share-based compensation expense Provision for losses and sales adjustments – accounts receivable Operating lease right-of-use assets – non cash Deferred income tax benefit Changes in operating assets and liabilities, exclusive of effects of acquired companies: Accounts receivable Income tax receivable Prepaid expenses and other current assets Accounts payable Operating lease liabilities Accrued liabilities Deferred revenue Net cash provided by operating activities Cash flows from investing activities: Additions to property and equipment Purchase of marketable security investments Proceeds from marketable security investments Purchase of equity investment in common shares Proceeds from the sale of equity investment in preferred shares Capitalized software development costs Cost of acquisitions, net of cash acquired Decrease (increase) in other Net cash used by investing activities Cash flows from financing activities: Decrease in net borrowings on revolving line of credit Purchase of treasury shares Payment of contingent consideration Proceeds from exercise of stock options Contributions from employee stock purchase plan Net cash provided (used) by financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period See accompanying notes. 2020 2019 2018 For the years ended December 31, 2020, 2019, and 2018 $ 194,820 $ 146,527 $ 147,462 81,657 67,365 3,517 5,782 (7,936) (10,733) (15,117) (8,304) (967) (6,549) 2,870 48,684 355,089 (22,690) (156,618) 82,742 (10,000) 15,000 (5,776) (1,292) 314 (98,320) — (15,484) (5,619) 124,363 10,912 114,172 370,941 232,682 $ 603,623 76,672 59,967 1,636 5,397 (6,088) (65,738) (1,925) (8,976) 7,403 (6,113) 1,516 44,442 254,720 (37,236) (54,742) 70,796 — — (4,804) (218,734) (295) (245,015) — (17,786) — 96,908 9,576 88,698 98,403 134,279 $ 232,682 61,759 52,740 (569) — (5,069) (50,916) 6,642 (588) (2,416) — (2,445) 43,603 250,203 (27,424) (115,625) 81,205 — — — (178,093) 1,682 (238,255) — (146,553) — 74,907 8,051 (63,595) (51,647) 185,926 $ 134,279 (In thousands) Balance at December 31, 2017 Net income Issuance of shares pursuant to stock compensation plan Stock compensation Issuance of shares pursuant to employee stock purchase plan Treasury stock purchases Balance at December 31, 2018 Net income Retained earnings adjustment-adoption of Topic 842 Leases, net of taxes Exercise of stock options and vesting of restricted stock units Employee taxes paid for withheld shares for taxes upon equity award settlement Stock compensation Issuance of shares pursuant to employee stock purchase plan Treasury stock purchases Balance at December 31, 2019 Net income Exercise of stock options and vesting of restricted stock units Employee taxes paid for withheld shares for taxes upon equity award settlement Stock compensation Issuance of shares pursuant to employee stock purchase plan Treasury stock purchases Balance at December 31, 2020 See accompanying notes. Common Stock Shares Amount Additional Paid-in Capital Accumulated Other Comprehensive Retained Earnings Income (Loss) Treasury Stock Shares Amount Total Shareholders’ Equity 48,148 — — — — — 48,148 — $ 481 — $ 626,867 — $ (46) — $ 624,463 147,462 (10,262) — $ (60,029) — $ 1,191,736 147,462 — — — — 481 — 44,458 52,740 7,370 — 731,435 –– — — — — (46) — — — 1,126 — 30,449 — 74,907 52,740 — — 771,925 146,527 45 (781) (9,872) — 681 (150,050) (178,949) — 8,051 (150,050) 1,324,846 146,527 — — — — (1,116) — — (1,116) — — (52,833) — — — — — 48,148 — — — — — 481 — — 59,967 909 — 739,478 — — — 90,636 — — — — 48,148 — — — — $ 481 — 67,365 7,853 — $ 905,332 — — — 1,075 149,741 96,908 (23) — (5,361) — (5,361) 59,967 — — 917,336 194,820 53 (72) (8,839) — 8,667 (14,289) (40,191) — 9,576 (14,289) 1,617,058 194,820 — — — 1,283 33,727 124,363 (34) — (12,923) — (12,923) 67,365 — — — — (46) — — — — — — $ (46) — — $ 1,112,156 40 (59) (7,609) 3,059 (15,484) $ (31,812) 10,912 (15,484) $ 1,986,111 6 0 \ / 6 1 (Tables in thousands, except per share data) (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS We provide integrated software systems and related services for the public sector, with a focus on local governments. We develop and market a broad line of software solutions and services to address the information technology (“IT”) needs primarily of cities, counties, schools and other local government entities. In addition, we provide professional IT services, including software and hardware installation, data conversion, training, and for certain customers, product modifications, along with continuing maintenance and support for customers using our systems. We also provide subscription-based services such as software as a service (“SaaS”) arrangements, which primarily utilize the Tyler private cloud, and electronic document filing solutions (“e-filing”). In addition, we provide property appraisal outsourcing services for taxing jurisdictions. Impact of the COVID-19 Pandemic In March 2020, the World Health Organization declared the outbreak of a COVID-19 pandemic (“COVID-19”), which continues to spread throughout the U.S. and the world and has resulted in authorities implementing numerous measures to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders, and business limitations and shutdowns. While we are unable to accurately predict the full impact that COVID-19 will have on our results from operations, financial condition, liquidity and cash flows due to numerous uncertainties, including the duration and severity of the pandemic and containment measures and associated compliance, the current environment has negatively impacted our revenues for fiscal year 2020. Because an increasing portion of our revenues are considered recurring in nature, the effect of COVID-19 on our results of operations may also not be fully reflected for some time. We continue to see some impact on our business in the near term with delays in government procurement processes and uncertainty around public sector budgets, as well as delays in implementations caused by travel restrictions, closed offices, or clients shifting focus to more pressing issues. We have addressed those challenges through adapting the way we do business — encouraging web and video conferencing, conducting virtual sales demonstrations and delivering professional services remotely. Our priorities during this crisis are protecting the health and safety of our employees and our clients. Our IT systems and applications support a remote workforce. Prior to the pandemic, many of our employees worked remotely. In response to the pandemic, we encouraged all employees who are able to do so to work from home, equipping them with resources necessary to continue uninterrupted. We were able to transition the vast majority of our employees to this work-from-home posture. This reduces the number of team members in our offices to those uniquely needed for essential on-site services, such as network operations support staff, and allows for “social distancing” as directed by the Centers for Disease Control (“CDC”). The pandemic has delayed some government procurement processes and is expected to impact our ability to complete certain implementations, negatively impacting our revenue. It could also negatively impact the timing of client payments to us. We continue to monitor these trends in order to respond to the ever-changing impact of COVID-19 on our clients and Tyler’s operations. For the twelve months ended December 31, 2020, the impact of the COVID-19 pandemic resulted in lower revenues from software licenses, software services, appraisal services, and other revenues. Lower software licenses compared to prior periods are attributed to slower sales cycles as government procurement processes are delayed and contract signings have been pushed to future periods. Software services and appraisal services revenue declines are attributed to delays in implementations caused by travel restrictions and shelter-in-place orders in effect during the period. Other revenues were lower compared to prior periods primarily as a result of the cancellation of our 2020 Connect user conference. Lower revenues compared to prior periods were offset by cost savings attributed to lower spend on travel, user conferences and trade show expenses, health claims and other employee-related expenses. If, and as travel restrictions are relaxed, we expect software services and appraisal services revenues to increase as the limited number of our clients who require that all or a portion of their services be delivered onsite will be able to receive those services. Also, we are adapting by changing the way we do business, encouraging web and video conferencing, conducting virtual sales demonstrations and delivering professional services remotely, which result in increases in staff utilization rates and billable time. Revenues from subscriptions and maintenance, which we consider recurring in nature, comprised 73% of our total consolidated revenue for the twelve months ended December 31, 2020, and include transaction-based revenue streams such as e-filing and online payments. As of December 31, 2020, we had $758.5 million in cash and investments and no outstanding borrowings under our credit facility. We also have substantial additional liquidity available through our undrawn $400 million credit facility, which can be expanded through an accordion feature. During the second quarter of 2020, we completed our annual assessment of goodwill which did not result in an impairment charge. Since our assessment in the second quarter of 2020, we identified no indicators of impairment to goodwill; therefore, we have recorded no impairment as of and for the period ended December 31, 2020. We identified no indicators of impairment to long-lived and other assets and therefore, no impairment was recorded as of and for the period ended December 31, 2020. However, due to significant uncertainty surrounding COVID-19 and market conditions, there are no assurances conditions will not deteriorate in the future. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include our parent company and eleven subsidiaries, which are wholly-owned. All significant intercompany balances and transactions have been eliminated in consolidation. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions, and other events and circumstances from non-owner sources and includes all components of net income and other comprehensive income. We had no items of other comprehensive income during the years ended December 31, 2020, 2019, and 2018. CASH AND CASH EQUIVALENTS Cash in excess of that necessary for operating requirements is invested in short-term, highly liquid, income-producing investments. Investments with original maturities of three months or less are classified as cash and cash equivalents, which primarily consist of cash on deposit with several banks and money market funds. Cash and cash equivalents are stated at cost, which approximates market value. REVENUE RECOGNITION Nature of Products and Services We earn revenue from software licenses, royalties, subscription-based services, software services, post-contract customer support (“PCS” or “maintenance”), hardware and appraisal services. Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We determine revenue recognition through the following steps: Identification of the contract, or contracts, with a customer Identification of the performance obligations in the contract • • • Determination of the transaction price • Allocation of the transaction price to the performance obligations in the contract • Recognition of revenue when, or as, we satisfy a performance obligation Most of our software arrangements with customers contain multiple performance obligations that range from software licenses, installation, training, and consulting to software modification and customization to meet specific customer needs (services), hosting, and PCS. For these contracts, we account for individual performance obligations separately when they are distinct. We evaluate whether separate performance obligations can be distinct or should be accounted for as one performance obligation. Arrangements that include software services, such as training or installation, are evaluated to determine whether those services are highly interdependent or interrelated to the product’s functionality. The transaction price is allocated to the distinct performance obligations on a relative standalone selling price (“SSP”) basis. We determine the SSP based on our overall pricing objectives, taking into consideration market conditions and other factors, including the value of our contracts, the applications sold, customer demographics, and the number and types of users within our contracts. Revenue is recognized net of allowances for sales adjustments and any taxes collected from customers, which are subsequently remitted to governmental authorities. 6 2 \ / 6 3 TYLER TECHNOLOGIES ANNUAL REPORT 2020TYLER TECHNOLOGIES ANNUAL REPORT 2020Notes to Consolidated Financial StatementsNotes to Consolidated Financial Statements Software Arrangements: Software Licenses and Royalties Many of our software arrangements involve “off-the-shelf” software. We recognize the revenue allocable to “off-the-shelf” software licenses and specified upgrades at a point in time when control of the software license transfers to the customer, unless the software is not considered distinct. We consider “off-the-shelf” software to be distinct when it can be added to an arrangement with minor changes in the underlying code, it can be used by the customer for the customer’s purpose upon installation, and remaining services such as training are not considered highly interdependent or interrelated to the product’s functionality. For arrangements that involve significant production, modification or customization of the software, or where software services are otherwise not considered distinct, we recognize revenue over time by measuring progress-to-completion. We measure progress-to-completion primarily using labor hours incurred as it best depicts the transfer of control to the customer which occurs as we incur costs on our contracts. These arrangements are often implemented over an extended period and occasionally require us to revise total cost estimates. Amounts recognized in revenue are calculated using the progress-to-completion measurement after giving effect to any changes in our cost estimates. Changes to total estimated contract costs, if any, are recorded in the period they are determined. Estimated losses on uncompleted contracts are recorded in the period in which we first determine that a loss is apparent. Software license fees are billed in accordance with the contract terms. Typically, a majority of the fee is due when access to the software license is made available to the customer and the remainder of the fee due over a passage of time stipulated by the contract. We record amounts that have been invoiced in accounts receivable and in deferred revenue or revenues, depending on whether the revenue recognition criteria have been met. We recognize royalty revenue when the sale occurs under the terms of our third-party royalty arrangements. Currently, our third-party royalties are recognized on an estimated basis and adjusted if needed, when we receive notice of amounts we are entitled to receive. We typically receive notice of royalty revenues we are entitled to and billed on a quarterly basis in the quarter immediately following the royalty reporting period. Software Services As noted above, some of our software arrangements include services considered highly interdependent or highly interrelated or require significant customization to meet the customer’s desired functionality. For these software arrangements, both the software licenses and related software services revenue are not distinct and are recognized over time using the progress-to-completion method. We measure progress-to-completion primarily using labor hours incurred as it best depicts the transfer of control to the customer which occurs as we incur costs on our contracts. Contract fees are typically billed on a milestone basis as defined within contract terms. We record amounts that have been invoiced in accounts receivable and in deferred revenue or revenues, depending on whether the revenue recognition criteria have been met. When software services are distinct, the fee allocable to the service element is recognized over the time we perform the services and is billed on a time and material basis. Subscription-Based Services: Subscription-based services consist primarily of revenues derived from SaaS arrangements, typically utilizing the Tyler private cloud, and electronic filing transactions. Revenue from subscription-based services is generally recognized over time on a ratable basis over the contract term, beginning on the date that our service is made available to the customer. Our subscription contracts are generally three to five years or longer in length and billed annually in advance. For SaaS arrangements, we evaluate whether the customer has the contractual right to take possession of our software at any time during the hosting period without significant penalty and whether the customer can feasibly maintain the software on the customer’s hardware or enter into another arrangement with a third-party to host the software. We allocate contract value to each performance obligation of the arrangement that qualifies for treatment as a distinct element based on estimated SSP. We recognize SaaS services ratably over the term of the arrangement, which range from one to ten years, but are typically for a period of three to five years. For software services associated with certain SaaS arrangements, we have concluded that the services are not distinct, and we recognize the revenue ratably over the remaining contractual period once we have provided the customer access to the software. We record amounts that have been invoiced in accounts receivable and in deferred revenue or revenues, depending on whether the revenue recognition criteria have been met. Electronic filing transaction fees primarily pertain to documents filed with the courts by attorneys and other third-parties via our e-filing services and retrieval of filed documents via our access services. For each document filed with a court, the filer generally pays a transaction fee and a court filing fee to us and we remit a portion of the transaction fee and the filing fee to the court. We record as revenue the transaction fee, while the portion of the transaction fee remitted to the courts is recorded as cost of revenues as we are acting as a principal in the arrangement. Court filing fees collected on behalf of the courts and remitted to the courts are recorded on a net basis and thus do not affect the statement of comprehensive income. Other transaction-based fees primarily relate to online payment services, which are offered with the assistance of third-party vendors. In general, when we are the principal in a transaction based on the factors identified in ASC 606-10-55-36 through 55-40, we record the revenue and related costs on a gross basis. Otherwise, we net the cost of revenue associated with the service against the gross revenue (amount billed to the customer) and record the net amount as revenue. For e-filing transaction fees and certain other transaction-based revenues, we have the right to charge the customer an amount that directly corresponds with the value to the customer of our performance to date. Therefore, we recognize revenue for these services over time based on the amount billable to the customer in accordance with the ‘as invoiced’ practical expedient in ASC 606-10-55-18. In some cases, we are paid on a fixed fee basis and recognize the revenue ratably over the contractual period. Costs of performing services under subscription-based arrangements are expensed as incurred, except for certain direct and incremental contract origination and set-up costs associated with SaaS arrangements. Such direct and incremental costs are capitalized and amortized ratably over the useful life. Post-Contract Customer Support Appraisal Services: Our customers generally enter into PCS agreements when they purchase our software licenses. PCS includes telephone support, bug fixes, and rights to upgrades on a when-and-if available basis. PCS is considered distinct when purchased with our software licenses. Our PCS agreements are typically renewable annually. PCS is recognized over time on a straight-line basis over the period the PCS is provided. All significant costs and expenses associated with PCS are expensed as incurred. Computer Hardware Equipment Revenue allocable to computer hardware equipment is recognized at a point in time when control of the equipment is transferred to the customer. For our property appraisal projects, we recognize revenue using the progress-to-completion method since many of these projects are executed over one to three-year periods and consist of various unique activities. Appraisal services require a significant level of integration and interdependency with various individual service components; therefore, the service components are not considered distinct. Appraisal services are recognized over time by measuring progress-to-completion primarily using labor hours incurred as it best depicts the transfer of control to the customer which occurs as we incur costs on our contracts. These arrangements are often executed over an extended period and occasionally require us to revise total cost estimates. Amounts recognized in revenue are calculated using the progress-to-completion measurement after giving effect to any changes in our cost estimates. Changes to total estimated contract costs, if any, are recorded in the period they are determined. Estimated losses on uncompleted contracts are recorded in the period in which we first determine that a loss is apparent. Contract fees are typically billed on a milestone basis as defined within contract terms. We record amounts that have been invoiced in accounts receivable and in deferred revenue or revenues, depending on whether the revenue recognition criteria have been met. 6 4 \ / 6 5 TYLER TECHNOLOGIES ANNUAL REPORT 2020TYLER TECHNOLOGIES ANNUAL REPORT 2020Notes to Consolidated Financial StatementsNotes to Consolidated Financial Statements Significant Judgments: Our contracts with customers often include multiple performance obligations to a customer. When a software arrangement (license or subscription) includes both software licenses and software services, judgment is required to determine whether the software license is considered distinct and accounted for separately, or not distinct and accounted for together with the software services and recognized over time. The transaction price is allocated to the separate performance obligations on a relative SSP basis. We determine the SSP based on our overall pricing objectives, taking into consideration market conditions and other factors, including the value of our contracts, the applications sold, customer demographics, and the number and types of users within our contracts. We use a range of amounts to estimate SSP when we sell each of the products and services separately and need to determine whether there is a discount to be allocated based on the relative SSP of the various products and services. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine SSP using the expected cost-plus margin approach. For arrangements that involve significant production, modification or customization of the software, or where software services otherwise cannot be considered distinct, we recognize revenue as control is transferred to the customer over time using progress-to-completion methods. Depending on the contract, we measure progress-to-completion primarily using labor hours incurred, or value added. The progress-to-completion method generally results in the recognition of reasonably consistent profit margins over the life of a contract because we can provide reasonably dependable estimates of contract billings and contract costs. We use the level of profit margin that is most likely to occur on a contract. If the most likely profit margin cannot be precisely determined, the lowest probable level of profit margin in the range of estimates is used until the results can be estimated more precisely. These arrangements are often implemented over an extended time period and occasionally require us to revise total cost estimates. Amounts recognized in revenue are calculated using the progress-to-completion measurement after giving effect to any changes in our cost estimates. Changes to total estimated contract costs, if any, are recorded in the period they are determined. Estimated losses on uncompleted contracts are recorded in the period in which we first determine that a loss is apparent. Typically, the structure of our arrangements does not give rise to variable consideration. However, in those instances whereby variable consideration exists, we include in our estimates, additional revenue for variable consideration when we believe we have an enforceable right, the amount can be estimated reliably and its realization is probable. Refer to Note 15 — “Disaggregation of Revenue” for further information, including the economic factors that affect the nature, amount, timing, and uncertainty of revenue and cash flows of our various revenue categories. Contract Balances: Accounts receivable and allowance for losses and sales adjustments Timing of revenue recognition may differ from the timing of invoicing to customers. We record an unbilled receivable when revenue is recognized prior to invoicing, or deferred revenue when revenue is recognized subsequent to invoicing. For multi-year agreements, we generally invoice customers annually at the beginning of each annual coverage period. We record an unbilled receivable related to revenue recognized for on-premises licenses as we have an unconditional right to invoice and receive payment in the future related to those licenses. In connection with our appraisal services contracts and certain software services contracts, we may perform work prior to when the software and services are billable and/or payable pursuant to the contract. Unbilled revenue is not billable at the balance sheet date but is recoverable over the remaining life of the contract through billings made in accordance with contractual agreements. The termination clauses in most of our contracts provide for the payment for the value of products delivered or services performed in the event of early termination. We have historically recorded such unbilled receivables (costs and estimated profit in excess of billings) in connection with (1) property appraisal services contracts accounted for using progress-to-completion method of revenue recognition using labor hours as a measure of progress towards completion in which the services are performed in one accounting period but the billing normally occurs subsequently and may span another accounting period; (2) software services contracts accounted for using progress-to-completion method of revenue recognition using labor hours as a measure of progress towards completion in which the services are performed in one accounting period but the billing for the software element of the arrangement may be based upon the specific phase of the implementation; (3) software revenue for which we have recognized revenue at the point in time when the software is made available to the customer but the billing has not yet been submitted to the customer; (4) some of our contracts which provide for an amount to be withheld from a progress billing (generally between 5% and 20% retention) until final and satisfactory project completion is achieved; and (5) in a limited number of cases, extended payment terms, which may be granted to customers with whom we generally have a long-term relationship and favorable collection history. As of December 31, 2020, and December 31, 2019, total current and long-term accounts receivable, net of allowance for losses and sales adjustments, was $403.7 million and $396.5 million, respectively. We have recorded unbilled receivables of $140.8 million and $134.0 million at December 31, 2020, and December 31, 2019, respectively. Included in unbilled receivables are retention receivables of $13.1 million at December 31, 2020, and December 31, 2019, which become payable upon the completion of the contract or completion of our fieldwork and formal hearings. Unbilled receivables expected to be collected within one year have been included with accounts receivable, current portion in the accompanying consolidated balance sheets. Unbilled receivables and retention receivables expected to be collected past one year have been included with accounts receivable, long-term portion in the accompanying consolidated balance sheets. Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 90 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we have determined our contracts generally do not include a significant financing component. The primary purpose of our invoicing terms is to provide customers with simplified and predictable ways of purchasing our products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with revenue recognized ratably over the contract period, and multi-year on-premises term licenses that are invoiced annually with revenue recognized upfront. We maintain allowances for losses and sales adjustments, which losses are recorded against revenue at the time the loss is incurred. Since most of our clients are domestic governmental entities, we rarely incur a credit loss resulting from the inability of a client to make required payments. Events or changes in circumstances that indicate the carrying amount for the allowances for losses and sales adjustments may require revision, include, but are not limited to, managing our client’s expectations regarding the scope of the services to be delivered and defects or errors in new versions or enhancements of our software products. Our allowance for losses and sales adjustments of $9.3 million and $5.7 million at December 31, 2020, and December 31, 2019, respectively, does not include provisions for credit losses. As of January 1, 2020, we adopted ASU 2016-13 and primarily evaluated our historical experience with credit losses related to trade and other receivables. Because we have not experienced any historical credit losses with the majority of our clients, we have no basis to record a reserve for credit losses as defined by the standard. 6 6 \ / 6 7 TYLER TECHNOLOGIES ANNUAL REPORT 2020TYLER TECHNOLOGIES ANNUAL REPORT 2020Notes to Consolidated Financial StatementsNotes to Consolidated Financial Statements The following table summarizes the changes in the allowance for losses and sales adjustments: RESEARCH AND DEVELOPMENT COSTS 2019 2018 We expensed research and development expense of $88.4 million in 2020, $81.3 million in 2019, and $63.3 million in 2018. Years Ended December 31, Balance at beginning of year Provisions for losses and sales adjustments – accounts receivable Collections of accounts previously written off Balance at end of year Deferred Revenue 2020 $ 5,738 3,517 — $ 9,255 $ 4,647 1,636 (545) $ 5,738 $ 5,427 (569) (211) $ 4,647 The majority of deferred revenue consists of deferred maintenance revenue that has been billed based on contractual terms in the underlying arrangement, with the remaining balance consisting of payments received in advance of revenue being earned under software licensing, subscription-based services, software and appraisal services and hardware installation. Refer to Note 16 — “Deferred Revenue and Performance Obligations” for further information, including deferred revenue by segment and changes in deferred revenue during the period. Deferred Commissions Sales commissions earned by our sales force are considered incremental and recoverable costs of obtaining a contract with a customer. Sales commissions for initial contracts are deferred and then amortized commensurate with the recognition of associated revenue over a period of benefit that we have determined to be three to seven years. We utilized the “portfolio approach” practical expedient in ASC 606-10-10-4, which allows entities to apply the guidance to a portfolio of contracts with similar characteristics because the effects on the financial statements of this approach would not differ materially from applying the guidance to individual contracts. Using the “portfolio approach”, we determined the period of benefit by taking into consideration our customer contracts, our technology life-cycle and other factors. Sales commissions for renewal contracts are generally not paid in connection with the renewal of a contract. In the small number of instances where a commission is paid on a renewal, it is not commensurate with the commission paid on the initial sale and is recognized over the term of renewal, which is generally one year. Amortization expense related to deferred commissions is included in selling, general and administrative expenses in the accompanying consolidated statements of income. Refer to Note 17 — “Deferred Commissions” for further information. Prepaid expenses and other current assets include direct and incremental costs such as commissions associated with arrangements for which revenue recognition has been deferred. Such costs are expensed at the time the related revenue is recognized. USE OF ESTIMATES The preparation of our financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items subject to such estimates and assumptions include revenue recognition, determining the nature and timing of satisfaction of performance obligations, determining the SSP of performance obligations, variable consideration, and other obligations such as returns and refunds; loss contingencies; the estimated useful life of deferred commissions; the carrying amount and estimated useful lives of intangible assets; the carrying amount of operating lease right-of-use assets and operating lease liabilities; determining share-based compensation expense; the allowance for losses and sales adjustments; and determining the potential outcome of future tax consequences of events that have been recognized on our consolidated financial statements or tax returns. Actual results could differ from estimates. PROPERTY AND EQUIPMENT, NET Property, equipment and purchased software are recorded at original cost and increased by the cost of any significant improvements after purchase. We expense maintenance and repairs when incurred. Depreciation and amortization is calculated using the straight-line method over the shorter of the asset’s estimated useful life or the term of the lease in the case of leasehold improvements. For income tax purposes, we use accelerated depreciation methods as allowed by tax laws. INCOME TAXES Income taxes are accounted for under the asset and liability method. Deferred taxes arise because of different treatment between financial statement accounting and tax accounting, known as “temporary differences”. We record the tax effect of these temporary differences as “deferred tax assets” (generally items that can be used as a tax deduction or credit in the future periods) and “deferred tax liabilities” (generally items that we received a tax deduction for, which have not yet been recorded in the income statement). The deferred tax assets and liabilities are measured using enacted tax rules and laws that are expected to be in effect when the temporary differences are expected to be recovered or settled. A valuation allowance would be established to reduce deferred tax assets if it is more likely than not that a deferred tax asset will not be “realized”. SHARE-BASED COMPENSATION We have a share-based award plan that provides for the grant of stock options, restricted stock units, and performance share units to key employees, directors and non-employee consultants. Stock options generally vest after three to six years of continuous service from the date of grant and have a contractual term of 10 years. Restricted stock unit grants generally vest ratably over three to five years of continuous service from the date of grant. Each performance share unit represents the right to receive one share of our common stock based on our achievement of certain financial performance targets during applicable performance periods. We account for share-based compensation utilizing the fair value recognition pursuant to ASC 718, Stock Compensation. Refer to Note 9 — “Share-Based Compensation” for further information. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill Goodwill represents the excess of the purchase price over the fair value of net assets acquired, including identifiable intangible assets, in connection with our business combinations. Upon acquisition, goodwill is assigned to the reporting unit that is expected to benefit from the synergies of the business combination, which is the reporting unit to which the related acquired technology is assigned. A reporting unit is the operating segment, or a business unit one level below that operating segment, for which discrete financial information is prepared and regularly reviewed by executive management. We assess goodwill for impairment annually as of April 1st, or more frequently whenever events or changes in circumstances indicate its carrying value may not be recoverable. We begin with the qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying value before applying the quantitative assessment described below. If it is determined through the evaluation of events or circumstances that the carrying value may not be recoverable, we perform a comparison of the estimated fair value of the reporting unit to which the goodwill has been assigned to the sum of the carrying value of the assets and liabilities of that unit. If the sum of the carrying value of the assets and liabilities of a reporting unit exceeds the estimated fair value of that reporting unit, an impairment charge is recorded against goodwill for the amount of that excess. The impairment is limited to the amount of goodwill in that reporting unit. The fair values calculated in our impairment tests are determined using discounted cash flow models involving several assumptions. The assumptions that are used are based upon what we believe a hypothetical marketplace participant would use in estimating fair value. We evaluate the reasonableness of the fair value calculations of our reporting units by comparing the total of the fair value of all of our reporting units to our total market capitalization. As part of our annual impairment test, our qualitative assessments included our estimated effects of COVID-19 for all reporting units except for the data and insights reporting unit. As a result of these qualitative assessments, we determined that it was not more likely than not that an impairment existed; therefore, we did not perform a Step 1 quantitative impairment test. We did perform a quantitative assessment for goodwill of $75.7 million associated with our data and insights business unit and concluded no impairment existed as of our annual assessment date. 6 8 \ / 6 9 TYLER TECHNOLOGIES ANNUAL REPORT 2020TYLER TECHNOLOGIES ANNUAL REPORT 2020Notes to Consolidated Financial StatementsNotes to Consolidated Financial Statements For most of our reporting units, goodwill relates to a combination of legacy and acquired businesses and as a result those units have fair values that substantially exceed their underlying carrying values. For other reporting units, in particular our platform technologies and data and insights units, goodwill entirely relates to recently acquired businesses, and as a result those units do not have significant excess fair values over carrying values. The platform technologies and data and insights business units combined goodwill was $152.0 million, or 18%, of total goodwill as of December 31, 2020. Our annual goodwill impairment analysis did not result in an impairment charge. During 2020, we have recorded no impairment to goodwill as no triggering events or changes in circumstances indicating a potential impairment have occurred as of period-end. However, due to significant uncertainty surrounding COVID-19 and market conditions, there are no assurances conditions will not deteriorate in the future. Determining the fair value of our reporting units involves the use of significant estimates and assumptions and considerable management judgment. We base our fair value estimates on assumptions we believe to be reasonable at the time, but such assumptions are subject to inherent uncertainty. Changes in market conditions or other factors outside of our control, such as a worsening of expected impact of COVID-19, could cause us to change key assumptions and our judgment about a reporting unit’s prospects. Similarly, in a specific period, a reporting unit could significantly underperform relative to its historical or projected future operating results. Either situation could result in a meaningfully different estimate of the fair value of our reporting units, and a consequent future impairment charge. There have been no impairments to goodwill in any of the periods presented. Refer to Note 4 — “Goodwill and Other Intangible Assets” for additional information. Other Intangible Assets We make judgments about the recoverability of purchased intangible assets other than goodwill whenever events or changes in circumstances indicate that an impairment may exist. Customer base and acquired software each comprise approximately half of our purchased intangible assets other than goodwill. We review our customer turnover each year for indications of impairment. Our customer turnover has historically been very low. If indications of impairment are determined to exist, we measure the recoverability of assets by a comparison of the carrying amount of the asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of the assets exceeds their estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the assets exceeds the fair value of the assets. There have been no impairments of intangible assets in any of the periods presented. IMPAIRMENT OF LONG-LIVED ASSETS We periodically evaluate whether current facts or circumstances indicate that the carrying value of our property and equipment or other long- lived assets to be held and used may not be recoverable. If such circumstances are determined to exist, we measure the recoverability of assets to be held and used by a comparison of the carrying amount of the asset or appropriate grouping of assets and the estimated undiscounted future cash flows expected to be generated by the assets. If the carrying amount of the assets exceeds their estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell and would no longer be depreciated. The assets and liabilities of a disposal group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet. There was no impairment of long-lived assets in any of the periods presented. COSTS OF COMPUTER SOFTWARE We capitalize software development costs upon the establishment of technological feasibility and prior to the availability of the product for general release to customers. Software development costs primarily consist of personnel costs and rent for related office space. During the twelve months period ended December 31, 2020 and 2019, respectively, we capitalized approximately $5.8 million and $4.8 million 2019 of software development costs. We begin to amortize capitalized costs when a product is available for general release to customers. Amortization expense is determined on a product-by-product basis at a rate not less than straight-line basis over the product’s remaining estimated economic life of, generally, five years. Amortization of software development costs was approximately $1.2 million in 2020 and $0.3 million in 2019, and is included in cost of software license revenue in the accompanying consolidated statements of comprehensive income. We have not capitalized any internal use software development costs in any of the periods presented. CONTINGENT PURCHASE CONSIDERATION Contingent future cash payments related to acquisitions are recognized at fair value as of the acquisition date and included in the determination of the acquisition date purchase price. Subsequent changes in the fair value of the contingent future cash payments are recognized in earnings in the period that the change occurs. FAIR VALUE OF FINANCIAL INSTRUMENTS Cash and cash equivalents, accounts receivables, accounts payables, short-term obligations and certain other assets at cost approximate fair value because of the short maturity of these instruments. The fair value of our revolving line of credit would approximate book value as of December 31, 2020, because our interest rates reset approximately every 30 days or less. See Note 6 — “Revolving Line of Credit” for further discussion. As of December 31, 2020, we have $154.8 million in investment grade corporate bonds, municipal bonds and asset-backed securities with maturity dates ranging from 2021 through 2028. We intend to hold these bonds to maturity and have classified them as such. We believe cost approximates fair value because of the relatively short duration of these investments. The fair values of these securities are considered Level II as they are based on inputs from quoted prices in markets that are not active or other observable market data. These investments are presented at amortized cost and are included in short-term investments and non-current investments in the accompanying condensed consolidated balance sheets. As of December 31, 2020, we have an accrued interest receivable balance of approximately $896,000 which is included in accounts receivable, net. We do not measure an allowance for credit losses for accrued interest receivables. We record any losses within the maturity period of the investment and any write-offs to accrued interest receivables are recorded as a reduction to interest income in the period of the loss. During the twelve months ended December 31, 2020, we have recorded no credit losses. Interest income and amortization of discounts and premiums are included in other income, net in the accompanying consolidated statements of income. During 2020, we sold our $15.0 million investment in convertible preferred stock representing a 20% interest in Record Holdings Pty Limited, a privately held Australian company specializing in digitizing the spoken word in court and legal proceedings to BFTR, LLC, a wholly owned subsidiary of Bison Capital Partners V L.P. During the same period, we purchased $10.0 million in common stock representing a 18% interest in BFTR, LLC. The investment in common stock is accounted under the cost method because we do not have the ability to exercise significant influence over the investee and the securities do not have readily determinable fair values. Our investment is carried at cost less any impairment write-downs. Periodically, our cost method investments are assessed for impairment. We do not reassess the fair value of cost method investments if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investments. No events or changes in circumstances have occurred during the period that require reassessment. There has been no impairment of our cost method investment for the periods presented. This investment is included in non-current investments and other assets in the accompanying consolidated balance sheets. 7 0 \ / 7 1 TYLER TECHNOLOGIES ANNUAL REPORT 2020TYLER TECHNOLOGIES ANNUAL REPORT 2020Notes to Consolidated Financial StatementsNotes to Consolidated Financial Statements CONCENTRATIONS OF CREDIT RISK RECLASSIFICATIONS Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash and cash equivalents, accounts receivable from trade customers, and investments in marketable securities. Our cash and cash equivalents primarily consist of operating account balances and money market funds, which are maintained at several major domestic financial institutions and the balances often exceed insured amounts. As of December 31, 2020, we had cash and cash equivalents of $603.6 million. We perform periodic evaluations of the credit standing of these financial institutions. Certain amounts for previous years have been reclassified to conform to the current year presentation. As of January 1, 2020, the land and vital records management business unit, which was previously reported in the ES segment, was moved to the A&T segment to reflect changes in the way in which management makes operating decisions, allocates resources, and manages the growth and profitability of the Company. Prior year amounts for the ES and A&T segments have been adjusted to reflect the segment change. Refer to Note 14 — “Segment and Related Information” for additional information. Concentrations of credit risk with respect to receivables are limited due to the size and geographical diversity of our customer base. Historically, our credit losses have not been significant. As a result, we do not believe we have any significant concentrations of credit risk as of December 31, 2020. We maintain allowances for losses and sales adjustments, which are provided at the time the revenue is recognized. Since most of our customers are domestic governmental entities, we rarely incur a loss resulting from the inability of a customer to make required payments. Events or changes in circumstances that indicate the carrying amount for the allowances for losses and sales adjustments may require revision include, but are not limited to, deterioration of a customer’s financial condition, failure to manage our customer’s expectations regarding the scope of the services to be delivered, and defects or errors in new versions or enhancements of our software products. LEASES We determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (“ROU”) assets, and operating lease liabilities, current and long-term, on our consolidated balance sheets. We currently do not have any finance lease arrangements. Operating lease ROU assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date of the lease in determining the present value of future payments. The operating lease ROU asset also includes any lease payments made and excludes lease incentives and initial direct costs incurred. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term. Leases with an initial term of 12 months or less are not recorded on the balance sheet; we recognize lease expense for these leases on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, which are generally accounted for as a single lease component. INDEMNIFICATION Most of our software license agreements indemnify our customers in the event that the software sold infringes upon the intellectual property rights of a third-party. These agreements typically provide that in such event we will either modify or replace the software so that it becomes non-infringing or procure for the customer the right to use the software. We have recorded no liability associated with these indemnifications, as we are not aware of any pending or threatened infringement actions that are possible losses. We believe the estimated fair value of these intellectual property indemnification clauses is minimal. We have also agreed to indemnify our officers and board members if they are named or threatened to be named as a party to any proceeding by reason of the fact that they acted in such capacity. We maintain directors’ and officers’ liability insurance coverage to protect against any such losses. We have recorded no liability associated with these indemnifications. Because of our insurance coverage, we believe the estimated fair value of these indemnification agreements is minimal. RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS In June 2016, the FASB issued ASU 2016-13, Financial Instruments — Credit Losses, (“ASU 2016-13”). ASU 2016-13 changes the impairment model for most financial assets and certain other instruments, including trade and other receivables, available for-sale debt securities, held- to-maturity debt securities and loans, and requires entities to use a new forward-looking expected loss model that will result in the earlier recognition of an allowance for losses. This update is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for a fiscal year beginning after December 15, 2018, including interim periods within that fiscal year. Entities apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. As of January 1, 2020, we adopted the new standard with no material impact of credit losses to our trade and other receivables, held-to-maturity debt securities and retained earnings included in our condensed consolidated financial statements. On January 26, 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for Goodwill Impairment. The new standard eliminates Step 2 from the goodwill impairment test. An entity should recognize a goodwill impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. This standard is effective for public business entities in fiscal years beginning after December 15, 2019, and the standard was adopted and applied prospectively by the Company as of January 1, 2020, but it did not have a significant impact on the Company’s financial statements and disclosures. NEW ACCOUNTING PRONOUNCEMENTS In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes, (“ASU 2019-12”) which simplifies the accounting for income taxes, eliminates certain exceptions within ASC 740, Income Taxes, and clarifies certain aspects of the current guidance to promote consistency among reporting entities. The new standard is effective for fiscal years beginning after December 15, 2020. Most amendments within the standard are required to be applied on a prospective basis, while certain amendments must be applied on a retrospective or modified retrospective basis. We do not expect adoption of this standard to have a material effect on our consolidated financial statements. (2) ACQUISITIONS 2019 On October 30, 2019, we acquired certain assets of Courthouse Technologies, Ltd (“CHT”), an industry-leading provider of jury management systems that offers a fully integrated, end-to-end SaaS solution to manage all facets of juror management, from source list generation to juror processing and payment. The total purchase price was approximately $20.4 million paid in cash. In 2020, our final valuation of the fair market value of CHT’s assets and liabilities resulted in the adjustment to the preliminary opening balance sheet. These adjustments related to an increased allocation to customer related intangibles and reduction to goodwill of approximately $1.7 million. On February 28, 2019, we acquired all of the capital stock of MP Holdings Parent, Inc. dba MicroPact (“MicroPact”), a leading provider of commercial off-the-shelf (“COTS”) solutions, including entellitrak®, a low-code application development platform for case management and business process management used extensively in the public sector. The total purchase price, net of cash acquired of $2.0 million, was approximately $201.8 million consisting of $198.2 million paid in cash. In 2020, we paid $5.6 million in contingent consideration. We have no contingent consideration accrued as of December 31, 2020. 7 2 \ / 7 3 TYLER TECHNOLOGIES ANNUAL REPORT 2020TYLER TECHNOLOGIES ANNUAL REPORT 2020Notes to Consolidated Financial StatementsNotes to Consolidated Financial Statements On February 1, 2019, we acquired all the assets of Civic, LLC (“MyCivic”), a company that provides software solutions to connect communities. The total purchase price was $3.7 million in cash. As of December 31, 2020, the purchase price allocations for CHT, MicroPact and MyCivic are complete. Our balance sheet as of December 31, 2020, reflects the allocation of the purchase price to the assets acquired based on their fair value at the date of each acquisition. The fair value of the assets and liabilities acquired are based on valuations using Level III, unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. The operating results of all 2019 acquisitions are included with the operating results of the Enterprise Software segment since their date of acquisition. In 2019, we incurred fees of approximately $1.1 million for financial advisory, legal, accounting, due diligence, valuation and other various services necessary to complete these acquisitions. These fees were expensed in 2019 and are included in selling, general and administrative expenses on the consolidated statement of comprehensive income. (3) PROPERTY AND EQUIPMENT, NET Property and equipment, net consists of the following at December 31: Land Building and leasehold improvements Computer equipment and purchased software Furniture and fixtures Transportation equipment Accumulated depreciation and amortization Property and equipment, net Useful Lives (years) 2020 2019 — 5-39 3-5 5 5 $ 18,653 147,729 108,571 30,666 295 305,914 (137,910) $ 168,004 $ 18,653 137,448 99,435 28,506 402 284,444 (112,583) $ 171,861 Depreciation expense was $25.5 million in 2020, $23.4 million in 2019, and $21.2 million in 2018. We paid $9.9 million and $20.8 million for real estate and the expansion of existing buildings in 2020 and 2019, respectively. (4) GOODWILL AND OTHER INTANGIBLE ASSETS The changes in the carrying amount of goodwill for the two years ended December 31, 2020 are as follows: Balance as of 12/31/2018 Goodwill acquired related to the purchase of MicroPact Goodwill acquired related to other acquisitions Balance as of 12/31/2019 Purchase price adjustments related to CHT acquisition Balance as of 12/31/2020 Enterprise Software $ 739,550 76,319 10,080 825,949 (1,689) $ 824,260 Appraisal and Tax $ 14,168 — — 14,168 — $ 14,168 Total $ 753,718 76,319 10,080 840,117 (1,689) $ 838,428 7 4 \ Other intangible assets and related accumulated amortization consists of the following at December 31: Gross carrying amount of other intangibles: Customer related intangibles Acquired software Trade names Capitalized software development costs Leases acquired Accumulated amortization Total other intangibles, net 2020 2019 $ 322,619 262,286 22,905 10,581 5,037 623,428 (292,239) $ 331,189 $ 321,019 262,286 22,905 4,804 5,037 616,051 (237,137) $ 378,914 Amortization expense for acquired software and capitalized software development costs are recorded to cost of revenues. Amortization expense for customer relationships and trade names are recorded to selling, general and administrative expenses. Total amortization expense for other intangibles was $55.1 million in 2020, $52.8 million in 2019, and $39.6 million in 2018. The amortization periods of other intangible assets are summarized in the following table: Non-amortizable intangibles: Goodwill Amortizable intangibles: Customer related intangibles Acquired software Trade names Capitalized software development costs Leases acquired December 31, 2020 December 31, 2019 Gross Carrying Amount Weighted Average Amortization Period Accumulated Amortization Gross Carrying Amount Weighted Average Amortization Accumulated Amortization Period $ 838,428 — $ — $ 840,117 — $ — $ 322,619 262,286 22,905 10,581 5,037 16 years 7 years 11 years 5 years 9 years $ 116,609 162,378 9,366 1,460 2,426 $ 321,019 262,286 22,905 4,804 5,037 16 years 7 years 11 years 5 years 9 years $ 97,320 130,416 7,205 296 1,900 Estimated annual amortization expense related to acquired leases will be recorded as a reduction to hardware and other revenue and is expected to be $525,000 in 2021, $525,000 in 2022, $525,000 in 2023, $525,000 in 2024, $397,000 in 2025, and $114,000 thereafter. Estimated annual amortization expense related to other intangibles, including customer relationships, acquired software, trade names and capitalized software development costs. Capitalized software in progress of $4.5 million has been excluded from the estimated annual amortization expense table below: 2021 2022 2023 2024 2025 Thereafter $ 54,411 50,713 32,562 31,978 30,622 123,805 $ 324,091 / 7 5 TYLER TECHNOLOGIES ANNUAL REPORT 2020TYLER TECHNOLOGIES ANNUAL REPORT 2020Notes to Consolidated Financial StatementsNotes to Consolidated Financial Statements (5) ACCRUED LIABILITIES Accrued liabilities consist of the following at December 31: Accrued wages, bonuses and commissions Other accrued liabilities (6) REVOLVING LINE OF CREDIT Reconciliation of the U.S. statutory income tax rate to our effective income tax expense rate for operations follows: Years Ended December 31, 2020 2019 2018 2020 2019 $ 63,814 19,270 $ 83,084 $ 49,126 26,108 $ 75,234 Federal income tax expense at statutory rate State income tax, net of federal income tax benefit Net operating loss carrybacks Excess tax benefits of share-based compensation Adjustments from the 2017 Tax Cuts and Jobs Act Tax credits Non-deductible business expenses Other, net $ 36,759 6,677 (3,445) (60,190) — (3,867) 4,199 89 $ (19,778) $ 33,566 6,999 — (29,819) — (3,446) 6,011 — $ 13,311 $ 32,733 7,953 — (32,487) (1,750) (3,715) 5,655 19 $ 8,408 On September 30, 2019, we entered into a $400 million credit agreement (the “Credit Facility”) with the various lenders party thereto and Wells Fargo Bank, National Association, as Administrative Agent. The Credit Facility provides for unsecured revolving credit in an aggregate principal amount of up to $400 million, including a $25 million sublimit for letters of credit. The Credit Facility matures on September 30, 2024. Borrowings under the Credit Facility may be used for general corporate purposes, including working capital requirements, acquisitions and share repurchases. Borrowings under the Credit Facility bear interest at a rate of either (1) Wells Fargo Bank’s prime rate (subject to certain higher rate determinations) plus a margin of 0.125% to 0.75% or (2) the 30, 60, 90 or 180-day LIBOR rate plus a margin of 1.125% to 1.75%. As of December 31, 2020, our interest rate was 3.38% under the prime rate option or approximately 1.27% under the 30-day LIBOR option. The Credit Facility requires us to maintain certain financial ratios and other financial conditions and prohibits us from making certain investments, advances, cash dividends or loans, and limits incurrence of additional indebtedness and liens. As of December 31, 2020, we were in compliance with those covenants. At December 31, 2020, we had no outstanding borrowings and had unused borrowing capacity of $400 million under the Credit Facility. In addition, as of December 31, 2020, we had one outstanding standalone letter of credit totaling $2 million in favor of a client contract. The letter of credit guarantees our performance under the contract and expires in 2021. We paid interest of $610,000 in 2020, $1,750,000 in 2019, and $770,000 in 2018. (7) INCOME TAX Income tax (benefit) provision on income from operations consists of the following: Years Ended December 31, 2020 2019 2018 $ (10,538) (1,304) (11,842) (7,936) $ (19,778) $ 12,814 6,585 19,399 (6,088) $ 13,311 $ 9,110 4,367 13,477 (5,069) $ 8,408 Current: Federal State Deferred 7 6 \ The Coronavirus Aid, Relief and Economic Security (“CARES”) Act, which was signed into law on March 27, 2020, provides an estimated $2.2 trillion to fight the COVID-19 pandemic and stimulate the U.S. economy. The assistance includes tax relief and government loans, and investments and grants for entities in affected industries (e.g., health care, airlines). The business tax provisions of the CARES Act include temporary changes to income and non-income based tax laws, including the ability to utilize net operating losses, interest expense deductions, alternative minimum tax credit refunds, charitable contributions, and depreciation of qualified improvement property. Measures not related to income-based taxes include (1) allowing an employer to pay its share of Social Security payroll taxes that would otherwise be due from the date of enactment through December 31, 2020, over the following two years and (2) allowing eligible employers subject to closure due to the COVID-19 pandemic to receive a 50% credit on qualified wages against their employment taxes each quarter, with any excess credits eligible for refunds. The most significant provision of the CARES Act impacting our accounting for income taxes is the five-year carryback allowance for taxable net operating losses generated in tax years in which the statutory federal income tax rate is 21.0%, to periods in which the statutory federal income tax rate is 35.0%. We intend to carry back our 2020 taxable loss into our 2015 tax year, which results in a $3.4 million income tax benefit in the current year. The tax effects of the major items recorded as deferred tax assets and liabilities as of December 31 are: Deferred income tax assets: Operating expenses not currently deductible Stock option and other employee benefit plans Loss and credit carryforwards Total deferred income tax assets Valuation allowance Total deferred income tax assets, net of valuation allowance Deferred income tax liabilities: Intangible assets Property and equipment Prepaid expenses Deferred revenue Total deferred income tax liabilities Net deferred income tax liabilities 2020 2019 $ 9,084 17,446 27,199 53,729 (1,490) 52,239 (76,766) (9,918) (6,869) 807 (92,746) $ (40,507) $ 10,214 19,308 23,841 53,363 (1,923) 51,440 (84,019) (9,265) (4,922) (1,676) (99,882) $ (48,442) / 7 7 TYLER TECHNOLOGIES ANNUAL REPORT 2020TYLER TECHNOLOGIES ANNUAL REPORT 2020Notes to Consolidated Financial StatementsNotes to Consolidated Financial Statements As of December 31, 2020, we had federal net operating loss carryforwards of approximately $81.5 million, after-tax state net operating loss carryforwards of approximately $3.5 million, and tax credit carryforwards of approximately $8.6 million. The federal net operating loss carryforward will begin to expire in 2032 if not utilized, and a portion of the state net operating loss and tax credit carryforwards begin expiring in 2021 if not utilized. The acquired carryforwards are subject to an annual limitation but are expected to be realized with the exception of certain state net operating loss and tax credit carryforwards. The valuation allowance disclosed in the table above relates to state net operating losses and tax credit carryforwards that are likely to expire before utilization. We believe it is more likely than not that all other deferred tax assets will be realized. 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. In connection with the acquisition of Socrata in 2018, we recorded a $1.9 million liability for an uncertain tax position associated with acquired tax credit carryforwards. The unrecognized tax benefits are included in deferred income taxes in our consolidated balance sheets. The entire amount, if recognized, would affect the effective tax rate. There was no change in the balance of unrecognized tax benefits during 2020. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues for the next 12 months. We are subject to U.S. federal income tax, as well as income tax of multiple state, local and foreign jurisdictions. We are routinely subject to income tax examinations by these taxing jurisdictions, but we do not have a history of, nor do we expect, any material adjustments as a result of these examinations. With few exceptions, major U.S. federal, state, local and foreign jurisdictions are no longer subject to examination for years before 2015. As of February 19, 2021, no significant adjustments have been proposed by any taxing jurisdiction. We paid income taxes, net of refunds received, of $3.3 million in 2020, $21.3 million in 2019, and $6.8 million in 2018. (8) SHAREHOLDERS’ EQUITY The following table details activity in our common stock: Stock option exercises Purchases of common stock Employee stock plan purchases Restricted stock units vested, net of withheld shares Years Ended December 31, 2020 2019 2018 Shares Amount Shares Amount Shares Amount 1,174 (59) 40 $ 124,363 (15,484) 10,912 999 (72) 53 $ 96,908 (14,289) 9,576 1,126 (781) 45 $ 74,907 (150,050) 8,051 upon award settlement 76 (12,923) 53 (5,361) — — As of February 19, 2021, we had authorization from our board of directors to repurchase up to 2.5 million additional shares of our common stock. (9) SHARE-BASED COMPENSATION Share-Based Compensation Plan In May 2018, stockholders approved the Tyler Technologies, Inc. 2018 Stock Incentive Plan (“the 2018 Plan”) which amended and restated the existing Tyler Technologies, Inc. 2010 Stock Option Plan (“the 2010 Plan”). Upon stockholder approval of the 2018 Plan, the remaining shares available for grant under the 2010 Plan were added to the shares authorized for grant under the 2018 Plan. Additionally, any awards previously granted under the 2010 Plan that expire unexercised or are forfeited are added to the shares authorized for grant under the 2018 Plan. During fiscal year 2020, we granted stock awards under the 2018 Plan in the form of stock options, restricted stock units and performance share units. Stock options generally vest after three to six years of continuous service from the date of grant and have a contractual term of 10 years. Once options become exercisable, the employee can purchase shares of our common stock at the market price on the date we granted the option. Restricted stock unit grants generally vest ratably over three to five years of continuous service from the date of grant. Each performance share unit represents the right to receive one share of our common stock based on our achievement of certain financial performance targets during applicable performance periods. We account for share-based compensation utilizing the fair value recognition pursuant to ASC 718, Stock Compensation. As of December 31, 2020, there were 2.5 million shares available for future grants under the plan from the 22.9 million shares previously approved by the shareholders. Determining Fair Value of Stock Compensation Valuation and Amortization Method. We estimate the fair value of stock option awards granted using the Black-Scholes option valuation model. For restricted stock unit and performance stock unit awards, we amortize the fair value of all awards on a straight-line basis over the requisite service periods, which are generally the vesting periods. Expected Life. The expected life of awards granted represents the period of time that they are expected to be outstanding. The expected life represents the weighted-average period the stock options are expected to be outstanding based primarily on the options’ vesting terms, remaining contractual life and the employees’ expected exercise based on historical patterns. Expected Volatility. Using the Black-Scholes option valuation model, we estimate the volatility of our common stock at the date of grant based on the historical volatility of our common stock. Risk-Free Interest Rate. We base the risk-free interest rate used in the Black-Scholes option valuation model on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term equal to the expected life of the award. Expected Dividend Yield. We have not paid any cash dividends on our common stock in more than ten years and we do not anticipate paying any cash dividends in the foreseeable future. Consequently, we use an expected dividend yield of zero in the Black-Scholes option valuation model. Expected Forfeitures. We use historical data to estimate pre-vesting option forfeitures. We record share-based compensation only for those awards that are expected to vest. The following weighted average assumptions were used for options granted: Years Ended December 31, Expected life (in years) Expected volatility Risk-free interest rate Expected forfeiture rate 2020 2019 2018 5.0 27.0% 0.4% —% 6.0 26.6% 1.8% —% 6.0 26.7% 2.7% —% 7 8 \ / 7 9 TYLER TECHNOLOGIES ANNUAL REPORT 2020TYLER TECHNOLOGIES ANNUAL REPORT 2020Notes to Consolidated Financial StatementsNotes to Consolidated Financial Statements Share-Based Award Activity Share-Based Compensation Expense The following table summarizes restricted stock unit and performance stock unit activity during fiscal year 2020 (shares in thousands): Unvested at January 1, 2019 Granted Vested Forfeited Unvested at December 31, 2019 Granted Vested Forfeited Unvested at December 31, 2020 Weighted Average Grant Date Fair Value per Share $ 221.25 241.19 221.15 229.75 231.57 379.94 232.59 266.94 $ 282.45 Number of Shares 334 256 (76) (14) 500 204 (110) (7) 587 Options granted, exercised, forfeited and expired are summarized as follows: Number of Shares Weighted Average Exercise Price Weighted Average Remaining Contractual Life (Years) Aggregate Intrinsic Value Outstanding at December 31, 2017 Granted Exercised Forfeited Outstanding at December 31, 2018 Granted Exercised Forfeited Outstanding at December 31, 2019 Granted Exercised Forfeited Outstanding at December 31, 2020 Exercisable at December 31, 2020 4,817 432 (1,126) (31) 4,092 162 (999) (29) 3,226 128 (1,174) (3) 2,177 1,424 $ 107.91 208.21 66.53 158.80 129.51 251.58 96.92 174.54 145.27 403.99 105.97 165.93 $ 181.63 $ 155.06 6 6 $ 554,709 $ 400,814 We had unvested options to purchase approximately 752,000 shares with a weighted average grant date exercise price of $231.93 as of December 31, 2020, and unvested options to purchase approximately 1.2 million shares with a weighted average grant date exercise price of $188.48 as of December 31, 2019. Other information pertaining to option activity was as follows during the twelve months ended December 31: Weighted average grant-date fair value of stock options granted Total intrinsic value of stock options exercised 2020 2019 2018 $ 98.69 $ 292,394 $ 74.54 $ 155,899 $ 66.52 $ 176,716 The following table summarizes share-based compensation expense related to share-based awards which is recorded in the consolidated statements of comprehensive income: Years Ended December 31, Cost of subscriptions, software services and maintenance Selling, general and administrative expenses Total share-based compensation expenses Excess tax benefit Net decrease in net income 2020 2019 2018 $ 18,125 49,240 67,365 (60,190) $ 7,175 $ 15,002 44,965 59,967 (29,819) $ 30,148 $ 13,588 39,152 52,740 (32,487) $ 20,253 As of December 31, 2020, we had $164.0 million of total unrecognized compensation cost related to unvested options and restricted stock units, net of expected forfeitures, which is expected to be amortized over a weighted average amortization period of 3.12 years. Employee Stock Purchase Plan Under our Employee Stock Purchase Plan (“ESPP”) participants may contribute up to 15% of their annual compensation to purchase common shares of Tyler. The purchase price of the shares is equal to 85% of the closing price of Tyler shares on the last day of each quarterly offering period. As of December 31, 2020, there were 664,000 shares available for future issuances under the ESPP from the 2.0 million shares previously approved by the stockholders. (10) EARNINGS PER SHARE Basic earnings and diluted earnings per share data were computed as follows: Years Ended December 31, 2020 2019 2018 Numerator for basic and diluted earnings per share: Net income Denominator: Weighted-average basic common shares outstanding Assumed conversion of dilutive securities: Share-based awards Denominator for diluted earnings per share – Adjusted weighted-average shares Earnings per common share: Basic Diluted $ 194,820 $ 146,527 $ 147,462 40,035 38,640 38,445 1,491 41,526 1,465 40,105 1,678 40,123 $ $ 4.87 4.69 $ $ 3.79 3.65 $ $ 3.84 3.68 Share-based awards representing the right to purchase common stock of 132,000 shares in 2020, 633,000 shares in 2019, and 888,000 shares in 2018 were not included in the computation of diluted earnings per share because their inclusion would have had an anti-dilutive effect. 8 0 \ / 8 1 TYLER TECHNOLOGIES ANNUAL REPORT 2020TYLER TECHNOLOGIES ANNUAL REPORT 2020Notes to Consolidated Financial StatementsNotes to Consolidated Financial Statements (11) LEASES As of December 31, 2020, maturities of lease liabilities were as follows (in thousands): We lease office facilities for use in our operations, as well as transportation and other equipment. Most of our leases are non-cancelable operating lease agreements and they expire in one year to seven years. Some of these leases include options to extend for up to 10 years. We had no finance leases and no related party lease agreements as of December 31, 2020. Operating lease costs were approximately $10.2 million in 2020, $9.9 million in 2019, and $7.4 million in 2018. The components of operating lease expense were as follows (in thousands): Lease Costs Financial Statement Classification Operating lease cost Short-term lease cost Variable lease cost Net lease cost Selling, general and administrative expenses Selling, general and administrative expenses Selling, general and administrative expenses For the years ended 2020 $ 6,524 1,940 1,760 $ 10,224 2019 $ 6,379 2,269 1,274 $ 9,922 As of December 31, ROU lease assets and lease liabilities for our operating leases were recorded in the consolidated balance sheet as follows (in thousands): Assets: Operating lease right-of-use assets Liabilities: Operating leases, short-term Operating leases, long-term Total lease liabilities Supplemental information related to leases was as follows: Other Information Cash Flows (in thousands): Cash paid amounts included in the measurement of lease liabilities: Operating cash outflows from operating leases Right-of-use assets obtained in exchange for lease obligations (non-cash): Operating leases Lease Term and Discount Rate: Weighted average remaining lease term (years) Weighted average discount rate 2020 2019 $ 18,734 $ 18,992 5,904 16,279 $ 22,183 6,387 16,822 $ 23,209 For the years ended 2020 2019 $ 8,131 $ 7,267 $ 5,524 $ 3,466 3 3.28% 4 4.00% Years ending December 31, 2021 2022 2023 2024 2025 Thereafter Total lease payments Less: Interest Present value of operating lease liabilities Rental Income from third parties Amount $ 7,015 4,853 3,826 3,337 2,198 2,537 23,766 (1,583) $ 22,183 We own office buildings in Bangor, Falmouth and Yarmouth, Maine; Lubbock and Plano, Texas; Troy, Michigan; Latham, New York; and Moraine, Ohio. We lease space in some of these buildings to third-party tenants. The property we lease to others under operating leases consists primarily of specific facilities where one tenant obtains substantially all of the economic benefit from the asset and has the right to direct the use of the asset. These non-cancelable leases expire between 2021 and 2025, some of which have options to extend the lease for up to five years. We determine if an arrangement is a lease at inception. None of our leases allow the lessee to purchase the leased asset. Rental income from third-party tenants was $1.1 million in 2020, $1.1 million in 2019, and $1.2 million in 2018. Rental income is included in hardware and other revenue on the consolidated statements of comprehensive income. Future minimum operating rental income based on contractual agreements is as follows (in thousands): Years ending December 31, 2021 2022 2023 2024 2025 Thereafter Total Amount $ 1,372 1,402 1,432 1,462 858 — $ 6,526 As of December 31, 2020, we had no additional significant operating or finance leases that had not yet commenced. (12) EMPLOYEE BENEFIT PLANS We provide a defined contribution plan for the majority of our employees meeting minimum service requirements. Eligible employees can contribute up to 30% of their current compensation to the plan subject to certain statutory limitations. We contribute up to a maximum of 3% of an employee’s compensation to the plan. We made contributions to the plan and charged operating results $12.7 million in 2020, $11.5 million in 2019, and $9.3 million in 2018. 8 2 \ / 8 3 TYLER TECHNOLOGIES ANNUAL REPORT 2020TYLER TECHNOLOGIES ANNUAL REPORT 2020Notes to Consolidated Financial StatementsNotes to Consolidated Financial Statements (13) COMMITMENTS AND CONTINGENCIES Security Incident On September 29, 2020, we filed a Current Report on Form 8-K reporting a security incident (the “Incident”) involving ransomware disrupting access to some of our internal IT systems and telephone systems. There is no evidence that the environments where we host client applications were affected, and our hosting services to those clients were not interrupted. There is also no evidence of malicious activity on client networks associated with the Incident. We contained the Incident and recovered from it, resuming normal operations with our clients. We will continue to deploy supplemental remediation efforts as necessary. As part of our immediate response to the Incident, we (1) shut down points of access to external systems and began investigating and remediating the problem; (2) engaged outside IT security and forensics experts to conduct a detailed review and help securely restore affected systems; (3) implemented targeted monitoring systems to supplement the systems we already had in place; and (4) notified law enforcement. We have cooperated with their investigation throughout. We promptly notified our clients of the Incident and provided timely updates to our clients through direct communications and updates to our website. Although we believe we have contained and recovered from the Incident, and that we have taken and will continue to take appropriate remediation steps, we are subject to risk and uncertainties as a result of the Incident. We believe we are in the final phases of our investigation, but there can be no assurance as to what the ongoing impact of the Incident will be, if any. The Incident caused an interruption in parts of our business. We have made insurance claims for lost revenue related to the Incident, (primarily software services revenue) for the year ended December 31, 2020. Insurance reimbursements pertaining to lost revenue represent a contingent gain and any recovery of these revenues will be recorded when received. We do not expect such gains to be material. We incurred $4.2 million in costs associated with the Incident as of December 31, 2020. As of December 31, 2020, we have recorded $1.1 million of accrued insurance recoveries and received $2.4 million of insurance recoveries related to the Incident. The recorded costs consisted primarily of payments to third-party service providers and consultants, including legal fees, and enhancements to our cybersecurity measures. It is expected that we will continue to incur costs related to our response, remediation, and investigatory efforts relating to the Incident. We maintain cybersecurity insurance coverage in an amount that we believe is adequate. Litigation Other than routine litigation incidental to our business, there are no material legal proceedings pending to which we are party or to which any of our properties are subject. (14) SEGMENT AND RELATED INFORMATION We provide integrated information management solutions and services for the public sector, with a focus on local governments. We provide our software systems and services and appraisal services through six business units, which focus on the following products: • financial management, education and planning, regulatory and maintenance software solutions; • financial management, municipal courts, planning, regulatory and maintenance, and land and vital records management software solutions; • courts and justice and public safety software solutions; • data and insights solutions; • platform technologies; and • appraisal and tax software solutions and property appraisal services. 8 4 \ In accordance with ASC 280-10, Segment Reporting, we report our results in two segments. The financial management, education and planning, regulatory and maintenance software solutions unit; financial management, municipal courts, planning, regulatory and maintenance, and land and vital records management software solutions unit; courts and justice and public safety software solutions unit; the data and insights solutions unit; and platform technologies solutions unit meet the criteria for aggregation and are presented in one reportable segment, Enterprise Software (“ES”). The ES segment provides public sector entities with software systems and services to meet their information technology and automation needs for mission-critical “back-office” functions such as: financial management and education, courts and justice, public safety, planning, regulatory and maintenance, land and vital records management, data and insights and platform technologies processes. The Appraisal and Tax (“A&T”) segment provides systems and software that automate the appraisal and assessment of real and personal property, land and vital records management as well as property appraisal outsourcing services for local governments and taxing authorities. Property appraisal outsourcing services include: the physical inspection of commercial and residential properties; data collection and processing; computer analysis for property valuation; preparation of tax rolls; community education; and arbitration between taxpayers and the assessing jurisdiction. We evaluate performance based on several factors, of which the primary financial measure is business segment operating income. We define segment operating income for our business units as income before noncash amortization of intangible assets associated with their acquisition, interest expense and income taxes. Segment operating income includes intercompany transactions. The majority of intercompany transactions relate to contracts involving more than one unit and are valued based on the contractual arrangement. Segment operating income for corporate primarily consists of compensation costs for the executive management team and certain accounting and administrative staff and share-based compensation expense for the entire company. Corporate segment operating income also includes revenues and expenses related to a company-wide user conference. Due to the shelter-in-place orders caused by the COVID-19 pandemic, we cancelled our company-wide user conference for the current year. The accounting policies of the reportable segments are the same as those described in Note 1, “Summary of Significant Accounting Policies”. As of January 1, 2020, the land and vital records management business unit, which was previously reported in the ES segment, was moved to the A&T segment to reflect changes in the way in which management makes operating decisions, allocates resources, and manages the growth and profitability of the Company. Prior year amounts for the ES and A&T segments have been adjusted to reflect the segment change. Segment assets primarily consist of net accounts receivable, prepaid expenses and other current assets and net property and equipment, and capitalized software development costs. Corporate assets primarily consist of cash and investments, prepaid insurance, intangibles associated with acquisitions, deferred income taxes and net property and equipment mainly related to unallocated information and technology assets. ES segment capital expenditures included $6.6 million in 2020 and $12.6 million in 2019 for the expansion of existing buildings and purchases of buildings and land. A&T segment capital expenditures included $3.3 million in 2020 and $8.2 million in 2019 for the expansion of existing buildings. For the year ended December 31, 2020 Revenues Software licenses and royalties Subscriptions Software services Maintenance Appraisal services Hardware and other Intercompany Total revenues Depreciation and amortization expense Segment operating income Capital expenditures Segment assets Enterprise Software Appraisal and Tax Corporate Totals $ 64,200 326,284 164,520 429,224 — 17,670 19,061 $ 1,020,959 67,411 285,271 11,099 $ 847,672 $ 8,964 24,364 21,889 38,289 21,127 121 70 $ 114,824 1,055 27,383 3,823 $ 94,149 $ — — — — — 11 (19,131) (19,120) 13,191 (86,104) 6,826 $ 1,665,453 $ $ 73,164 350,648 186,409 467,513 21,127 17,802 — $ 1,116,663 81,657 226,550 21,748 $ 2,607,274 / 8 5 TYLER TECHNOLOGIES ANNUAL REPORT 2020TYLER TECHNOLOGIES ANNUAL REPORT 2020Notes to Consolidated Financial StatementsNotes to Consolidated Financial Statements Enterprise Software Appraisal and Tax Corporate Totals (15) DISAGGREGATION OF REVENUE For the year ended December 31, 2019 Revenues Software licenses and royalties Subscriptions Software services Maintenance Appraisal services Hardware and other Intercompany Total revenues Depreciation and amortization expense Segment operating income Capital expenditures Segment assets For the year ended December 31, 2018 Revenues Software licenses and royalties Subscriptions Software services Maintenance Appraisal services Hardware and other Intercompany Total revenues Depreciation and amortization expense Segment operating income Capital expenditures Segment assets $ 90,808 279,282 179,865 393,521 — 16,553 15,290 $ 975,319 64,245 255,365 19,283 $ 833,203 Enterprise Software $ 81,299 205,193 161,612 349,387 — 18,387 12,764 $ 828,642 49,921 231,819 9,918 $ 554,960 $ 9,397 17,070 33,196 36,797 23,479 203 206 $ 120,348 970 26,918 8,436 $ 91,343 Appraisal and Tax $ 12,142 15,354 29,657 35,134 21,846 390 391 $ 114,914 1,123 28,434 1,241 $ 64,810 $ — — — — — 6,256 (15,496) (9,240) 11,457 (73,829) 10,379 $ 1,267,068 $ $ 100,205 296,352 213,061 430,318 23,479 23,012 — $ 1,086,427 76,672 208,454 38,098 $ 2,191,614 Corporate Totals $ — — — — — 4,881 (13,155) (8,274) 10,715 (68,572) 13,973 $ 1,171,193 $ $ 93,441 220,547 191,269 384,521 21,846 23,658 — $ 935,282 61,759 191,681 25,132 $ 1,790,963 Reconciliation of reportable segment operating income to the Company’s consolidated totals: 2020 2019 2018 Years Ended December 31, Total segment operating income Amortization of acquired software Amortization of customer and trade name intangibles Other income, net Income before income taxes $ 226,550 (31,962) (21,662) 2,116 $ 175,042 $ 208,454 (30,642) (21,445) 3,471 $ 159,838 $ 191,681 (22,972) (16,217) 3,378 $ 155,870 The tables below show disaggregation of revenue into categories that reflect how economic factors affect the nature, amount, timing, and uncertainty of revenue and cash flows. Timing of Revenue Recognition Timing of revenue recognition by revenue category during the period is as follows: For the year ended December 31, 2020 Revenues: Software licenses and royalties Subscriptions Software services Maintenance Appraisal services Hardware and other Total For the year ended December 31, 2019 Revenues: Software licenses and royalties Subscriptions Software services Maintenance Appraisal services Hardware and other Total For the year ended December 31, 2018 Revenues: Software licenses and royalties Subscriptions Software services Maintenance Appraisal services Hardware and other Total Products and services transferred at a point in time Products and services transferred over time $ 62,029 — — — — 17,802 $ 79,831 $ 11,135 350,648 186,409 467,513 21,127 — $ 1,036,832 Products and services transferred at a point in time Products and services transferred over time $ 84,900 — — — — 23,012 $ 107,912 $ 15,305 296,352 213,061 430,318 23,479 — $ 978,515 Products and services transferred at a point in time Products and services transferred over time $ 75,188 — — — — 23,658 $ 98,846 $ 18,253 220,547 191,269 384,521 21,846 — $ 836,436 Total $ 73,164 350,648 186,409 467,513 21,127 17,802 $ 1,116,663 Total $ 100,205 296,352 213,061 430,318 23,479 23,012 $ 1,086,427 Total $ 93,441 220,547 191,269 384,521 21,846 23,658 $ 935,282 8 6 \ / 8 7 TYLER TECHNOLOGIES ANNUAL REPORT 2020TYLER TECHNOLOGIES ANNUAL REPORT 2020Notes to Consolidated Financial StatementsNotes to Consolidated Financial Statements Recurring Revenue Changes in total deferred revenue, including long-term, were as follows: The majority of our revenue is comprised of recurring revenues from maintenance and subscriptions. Virtually all of our on-premises software clients contract with us for maintenance and support, which provides us with a significant source of recurring revenue. We generally provide maintenance and support for our on-premises clients under annual, or in some cases, multi-year contracts. The contract terms for subscription arrangements range from one to 10 years but are typically contracted for initial periods of three to five years. Non-recurring revenues are derived from all other revenue categories. Recurring revenues and non-recurring revenues recognized during the period are as follows: Balance at beginning of year Deferral of revenue Recognition of deferred revenue Balance at end of year 2020 $ 412,694 1,094,185 (1,045,501) $ 461,378 For the year ended December 31, 2020 Recurring revenues Non-recurring revenues Intercompany Total revenues For the year ended December 31, 2019 Recurring revenues Non-recurring revenues Intercompany Total revenues For the year ended December 31, 2018 Recurring revenues Non-recurring revenues Intercompany Total revenues (16) DEFERRED REVENUE AND PERFORMANCE OBLIGATIONS Total deferred revenue, including long-term, by segment is as follows: December 31, Enterprise Software Appraisal and Tax Corporate Totals Enterprise Software $ 755,508 246,390 19,061 $ 1,020,959 Enterprise Software $ 672,804 287,225 15,290 $ 975,319 Enterprise Software $ 554,581 261,297 12,764 $ 828,642 Appraisal and Tax $ 62,652 52,102 70 $ 114,824 Appraisal and Tax $ 53,866 66,276 206 $ 120,348 Appraisal and Tax $ 50,488 64,035 391 $ 114,914 Corporate $ — 11 (19,131) $ (19,120) Corporate $ — 6,256 (15,496) $ (9,240) Corporate $ — 4,881 (13,155) $ (8,274) Totals $ 818,160 298,503 — $ 1,116,663 Totals $ 726,670 359,757 — $ 1,086,427 Totals $ 605,069 330,213 — $ 935,282 2020 2019 $ 422,742 36,945 1,691 $ 461,378 $ 375,838 35,487 1,369 $ 412,694 Transaction Price Allocated to the Remaining Performance Obligations The aggregate amount of transaction price allocated to the remaining performance obligations represents contracted revenue that has not yet been recognized (“Backlog”), which includes deferred revenue and amounts that will be invoiced and recognized as revenue in future periods. Backlog as of December 31, 2020 was $1.59 billion, of which we expect to recognize approximately 49% as revenue over the next 12 months and the remainder thereafter. (17) DEFERRED COMMISSIONS Sales commissions earned by our sales force are considered incremental and recoverable costs of obtaining a contract with a customer. Sales commissions for initial contracts are deferred and then amortized commensurate with the recognition of associated revenue over a period of benefit that we have determined to be generally three to seven years. Deferred commissions were $32.3 million, $29.8 million, as of December 31, 2020, and 2019 respectively. Amortization expense was $11.9 million, $11.5 million, and $9.6 million for the twelve months ended December 31, 2020, 2019, and 2018, respectively. There were no indicators of impairment in relation to the costs capitalized for the periods presented. Deferred commissions have been included with prepaid expenses in the accompanying consolidated balance sheets. Amortization expense related to deferred commissions is included in selling, general and administrative expenses in the accompanying consolidated statements of comprehensive income. (18) SUBSEQUENT EVENTS The following events or transactions have occurred subsequent to December 31, 2020. NIC, Inc. On February 9, 2021, Tyler Technologies, Inc. (the “Company”) entered into an Agreement and Plan of Merger (the “Merger Agreement”) by and among the Company, Topos Acquisition, Inc., a Delaware corporation and wholly owned subsidiary of the Company (“Merger Sub”), and NIC Inc., a Delaware corporation (“NIC”). Pursuant to the Merger Agreement, and upon the terms and subject to the conditions therein, Merger Sub will merge with and into NIC (the “Merger”), with NIC surviving the Merger and continuing as a wholly owned subsidiary of the Company. Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger (the “Effective Time”), each issued and outstanding share of Common Stock prior to the Effective Time, par value $0.0001 per share, of NIC (the “NIC Common Stock”) other than (i) shares of NIC Common Stock owned directly or indirectly by the Company, NIC or any of their respective subsidiaries immediately prior to the Effective Time, including shares of NIC held as treasury stock, (ii) shares of NIC Common Stock as to which dissenters’ rights have been properly perfected, and (iii) shares of NIC Common Stock covered by unvested NIC restricted stock awards) will be converted in the Merger into the right to receive $34.00 in cash, without interest (the “Merger Consideration”). 8 8 \ / 8 9 TYLER TECHNOLOGIES ANNUAL REPORT 2020TYLER TECHNOLOGIES ANNUAL REPORT 2020Notes to Consolidated Financial StatementsNotes to Consolidated Financial Statements TYLER TECHNOLOGIES ANNUAL REPORT 2020 TYLER TECHNOLOGIES ANNUAL REPORT 2020 (19) QUARTERLY FINANCIAL INFORMATION (UNAUDITED) The following table contains selected financial information from unaudited statements of income for each quarter of 2020 and 2019: Quarters Ended 2020 2019 Dec. 31 Sept. 30 June 30 Mar. 31 Dec. 31 Sept. 30 June 30 Mar. 31 $ 283,285 138,669 48,412 54,094 1.29 $ $ 285,746 143,509 49,936 39,284 0.94 $ $ 271,091 131,203 41,811 53,892 1.30 $ $ 276,541 129,131 34,883 47,550 1.16 $ $ 288,837 142,275 47,790 46,790 1.15 $ $ 275,400 130,717 40,552 40,390 1.00 $ $ 275,124 127,860 36,419 31,999 0.80 $ $ 247,066 116,048 35,077 27,348 0.69 $ 41,925 41,606 41,416 41,144 40,736 40,280 39,813 39,585 Revenues Gross profit Income before income taxes Net income Earnings per diluted share Shares used in computing diluted earnings per share Notes to Consolidated Financial Statements Under the terms of the Merger Agreement, the completion of the Merger is subject to certain customary closing conditions, including, among others: (i) adoption of the Merger Agreement by the affirmative vote of the holders of at least a majority of the voting power of the outstanding shares of NIC Common Stock; (ii) the accuracy of the parties’ respective representations and warranties in the Merger Agreement, subject to specified materiality qualifications; (iii) compliance by the parties with their respective covenants in the Merger Agreement in all material respects; (iv) the absence of any order restraining, enjoining, or otherwise prohibiting the consummation of the Merger; and (v) the expiration of the waiting period applicable to the Merger under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. The Merger Consideration is expected to be financed with a combination of new debt and cash on the Company’s balance sheet. In connection with its entry into the Merger Agreement, the Company obtained a commitment from Goldman Sachs Bank USA for a $1.6 billion 364-day senior unsecured bridge loan facility, subject to customary conditions. The Merger Agreement and the consummation of the transactions contemplated thereby have been unanimously approved by the NIC board of directors, and the NIC board of directors has resolved to recommend to the stockholders of NIC to adopt the Merger Agreement, subject to its terms and conditions. The Merger Agreement provides that, at the Effective Time, with respect to NIC restricted stock awards, (i) each vested restricted stock award will be converted into the right to receive the Merger Consideration with respect to each share of NIC Common Stock subject to such awards, less applicable withholding of taxes and other authorized deductions, (ii) each outstanding unvested performance-based restricted stock award will automatically vest in full, in accordance with the terms of its award agreement, and be converted into the right to receive the Merger Consideration with respect to such number of shares of NIC Common Stock, less applicable withholding of taxes and other authorized deductions, and (iii) each outstanding unvested time-based restricted stock will be assumed by the Company and converted into corresponding awards relating to the Company’s Common Stock in accordance with the terms set forth in the Merger Agreement. The Merger Agreement contains customary representations, warranties and covenants made by each of the Company, Merger Sub, and NIC, including, among others, covenants by NIC regarding the conduct of its business during the pendency of the transactions contemplated by the Merger Agreement, public disclosures and other matters. NIC is required, among other things, not to solicit alternative business combination transactions and, subject to certain exceptions, not to engage in discussions or negotiations regarding an alternative business combination transaction. Both the Company and NIC may terminate the Merger Agreement under certain specified circumstances, including (i) if the Merger is not consummated by June 30, 2021, subject to an extension of up to three months in order to obtain required regulatory approval, (ii) if the approval of the NIC stockholders is not obtained, and (iii) if NIC’s board makes an adverse recommendation change with respect to the proposed transaction or approve or recommend a superior acquisition proposal. In certain circumstances in connection with the termination of the Merger Agreement, including if NIC’s board of directors changes or withdraws its recommendation of the Merger to its stockholders, fails to include its recommendation to shareholders in NIC’s proxy statement, or terminates the Merger Agreement to enter into an agreement with respect to a “superior proposal,” NIC will be required to pay the Company a termination fee of $55 million in cash. The foregoing description of the Merger Agreement does not purport to be complete and is qualified in its entirety by the full text of the Merger Agreement, a copy of which is filed as Exhibit 2.1 to our Form 8-K, dated February 10, 2021. 9 0 \ / 9 1 Notes to Consolidated Financial Statements Performance Graph The following table compares total shareholder returns for Tyler over the last five years to the Standard and Poor’s 500 Stock Index and the Standard and Poor’s 600 Information Technology Index assuming a $100 investment made on December 31, 2015. Each of the three measures of cumulative total return assumes reinvestment of dividends. The stock performance shown on the graph below is not necessarily indicative of future price performance. COMPARISON OF CUMULATIVE FIVE YEAR TOTAL RETURN $300 $250 $200 $150 $100 $50 $0 9 2 \ 2015 100 100 100 2016 81.90 111.96 133.85 2017 101.57 136.40 147.62 2018 106.60 130.42 134.43 2019 172.11 171.49 187.65 2020 250.41 203.04 239.83 Tyler Technologies, Inc. S&P 500 Stock Index S&P 600 Information Technology Index 2020 Corporate Officers Daniel M. Pope², ⁴ Mayor City of Lubbock, Texas H. Lynn Moore, Jr. President & Chief Executive Officer Brian K. Miller Executive Vice President Chief Financial Officer & Treasurer Matthew B. Bieri Chief Information Officer S. Brett Cate Chief Sales Officer Samantha B. Crosby Chief Marketing Officer Abigail M. Diaz Chief Legal Officer & Secretary Jason P. Durham Corporate Controller Bruce E. Graham Senior Strategy Advisor Jeffrey S. Green Chief Technology Officer Jeffrey D. Puckett Chief Strategy Officer Kelley B. Shimansky Chief Human Resources Officer W. Michael Smith Chief Accounting Officer Board of Directors H. Lynn Moore, Jr.¹ President & Chief Executive Officer Tyler Technologies, Inc. John S. Marr, Jr.¹ Executive Chairperson of the Board Tyler Technologies, Inc. Donald R. Brattain² President Brattain and Associates, LLC Glenn A. Carter³, ⁴ Retired Chief Executive Officer DataProse, Inc. Brenda A. Cline², ³ Executive Vice President Kimbell Art Foundation J. Luther King, Jr.⁴ Chief Executive Officer Luther King Capital Management Dustin R. Womble Retired Executive Vice President Tyler Technologies, Inc. Senator Mary Landrieu³ Senior Policy Advisor Van Ness Feldman, LLP 1 Executive Committee 2 Audit Committee 3 Nominating & Governance Committee 4 Compensation Committee Operational Leadership S. Franklin Williams III President Data & Insights Division Kristoffer L. Collo President Federal Division ENTERPRISE GROUP Christopher P. Hepburn President Enterprise Group Mark A. Hawkins President Appraisal & Tax Division Christopher J. Webster President ERP Division Dane L. Womble President Local Government Division JUSTICE GROUP D. Bret Dixon President Justice Group Russell J. Smith President Courts & Justice Division Bryan K. Proctor President Public Safety Division CORPORATE HEADQUARTERS 5101 Tennyson Parkway, Plano, Texas 75024 972.713.3700 • tylertech.com TRANSFER AGENT AND REGISTRAR American Stock Transfer & Trust Company 6201 15th Avenue, Brooklyn, New York 11219 800.937.5449 • help@astfinancial.com • amstock.com INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Ernst & Young LLP Dallas, Texas ANNUAL MEETING OF STOCKHOLDERS Tuesday, May 7, 2021 9 a.m. Central Time • Virtual www.virtualshareholdermeeting.com/TYL2021 CERTIFICATIONS We submitted an unqualified Annual CEO Certification to the New York Stock Exchange (NYSE) as required by the NYSE Listed Company rules. We also filed with the Securities and Exchange Commission the Chief Executive Officer and Chief Financial Officer certifications required under Section 302 of the Sarbanes- Oxley Act as exhibits to our Annual Report on Form 10-K. INVESTOR INFORMATION Our annual report on Form 10-K is available on the company’s website at tylertech.com. A copy of the Form 10-K or other information may also be obtained by contacting the Investor Relations Department at corporate headquarters. INVESTOR RELATIONS 972.713.3714 • info@tylertech.com COMMON STOCK Listed on the New York Stock Exchange under the symbol “TYL”