Hello, and welcome to today's Tyler Technologies 4th Quarter 2018 Conference Call. Your host for today's call is John Marr, Chairman of Tyler Technologies. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will follow at that time. And as a reminder, this conference is being recorded today, February 21, 2019.
I would like to turn the call over to Mr. Maher. Please go ahead, sir.
Thank you, and welcome to our Q4 2018 earnings call. With me on the call today are Lynn Moore, our President and Chief Executive Officer and Brian Miller, our Chief Financial Officer. First, I'd like for Brian to give the Safe Harbor statement, then Lynn will have some preliminary comments, then Brian will review the details of our 4th quarter results and provide our 2019 guidance. Then I'll have some final comments, and we'll take your questions. Brian?
Thanks, John. During the course of this conference call, management may make statements that provide information other than historical information and may include projections concerning the company's future prospects, revenues, expenses and profits. Such statements are considered forward looking statements under the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995 and are subject to certain risks and uncertainties, which could cause actual results to differ materially from these projections. We refer you to our Form 10 ks and other SEC filings for more information on those risks. Effective January 1, 2018, we adopted the requirements of ASU No.
20 fourteen-nine Topic 606, revenue from contracts with customers, utilizing the full retrospective method of transition. Prior year amounts have been restated from previously reported amounts to reflect the impact of the full retrospective adoption of Topic 606. Please note that all growth comparisons we make on the call today will relate to the corresponding period of last year unless we specify otherwise. Lynn?
Thanks, Brian. Our 4th quarter results provided a solid finish to 2018. This was our 29th consecutive quarter of double digit revenue growth as total GAAP revenues grew 11.2% and non GAAP revenues grew 11.5%. Organic growth improved from the 3rd quarter to 7.4% on a GAAP basis and 7.3% on a non GAAP basis. Revenue came in at the low end of our guidance range, primarily due to a higher level of software subscription contracts in the new business mix as well as the timing of several public safety deals that slipped out of the Q4.
With regard to growth expectations, we focus internally more on total growth than on the distinction between the organic and inorganic components. We've discussed before our expectation that over time, our organic growth likely slows somewhat. Part of that is simply due to large numbers, with revenues that will exceed $1,000,000,000 in 2019, achieving double digit growth organically is increasingly difficult in a market that grows in the mid single digit range, especially when combined with the near term revenue headwind that comes with the continuing shift towards software subscriptions in our new business mix. In addition, maintenance from on premises clients makes up about 40% of our revenues. And although we have extremely low attrition and a history of consistent annual increases in rates, those factors generally result in 6% to 7% growth in maintenance revenues.
Also, while appraisal services makes up less than 3% of our total revenues, they are cyclical in nature and in 2018 were down 12.7%. That decline alone reduced organic revenue growth 60 basis points for the year. Against that backdrop, we think it's especially important to note that our core software revenues, those revenues from licenses and subscriptions, are consistently growing organically in solid double digits. In the Q4, our core software license and subscription revenues grew 24% on a non GAAP basis, with 15% organic growth. And for the year, they grew 23% with 17% organic growth.
We also expect that we will continue to supplement our organic growth with strategic acquisitions. We are patient and disciplined acquirers and look for acquisitions that strengthen our product offerings, leverage our existing client base and sales resources and expand our addressable market, all at fair valuations. We believe that, as we have proven in the past, we will supplement our organic growth with these acquisitions and continue to achieve low double digit total growth. Software license and royalties revenues in the 4th quarter were very strong, up 15% and exceeded $25,000,000 for the first time. GAAP subscription revenues grew 26% and non GAAP subscription revenues grew 28%.
Total recurring revenues from maintenance and subscriptions grew 13% and comprised 65% of total revenue. Our mix of new business was similar to the 3rd quarter, with approximately 60% of the value of new software deals from on premises license arrangements and 40% from subscription arrangements. It was a particularly robust quarter for our ERP and Civic Services solutions, which had strong sales throughout the year. The largest deals of the quarter were a SaaS arrangement for Munis with the City of Memphis, Tennessee valued at approximately $4,000,000 an on premises license arrangement for Munis with Jackson, Mississippi valued at over $3,000,000 and contracts with Cape Coral, Florida for both Munis and EnerGov valued at $4,400,000 We also signed contracts valued at over $2,000,000 each with Tucson, Arizona for EnerGov and York County, Pennsylvania for Munis. For our Courts and Justice solutions, we expanded our presence with Odysee case management in the key states of Texas and Illinois with an on premises contract with Bell County, Texas and a SaaS contract with Midland County, Illinois, each valued at more than $2,500,000 While it was an active quarter for new business in the public safety market, contract signings for several opportunities in which we were selected slipped out of the Q4 for a variety of reasons.
Significant new on premises contracts signed in the quarter for our New World solution included Lake County, Ohio Duluth, Minnesota and Westlakeo, Texas, along with significant SaaS agreements with Kalamazoo, Michigan and Bethlehem, New York. We continue to gain momentum with sales for our Socrata data insight solution, which we acquired on April 30. We're particularly pleased with sales for the Socrata Connected Government Cloud or SCGC that we launched in May. Our 2018 goal was to sign 6 new SGC clients by year end and we far surpassed that with 18 SCGC sales across all levels of government in 2018. Among the 4th quarter SCGC contracts were deals with the City of Austin, Texas Fulton County, Georgia the Idaho Supreme Court and U.
S. Department of Transportation. Finally, we signed a significant contract for our Versatrans student transportation solutions with the First Student Inc. Organization, a leading provider of school bus transportation across North America. We are particularly pleased with our cash flow performance for the Q4 as well as for the full year.
Free cash flow grew 39% in the 4th quarter and 46% for the full year. With our strong cash flow and balance sheet, we continue to actively pursue strategic acquisitions that support our long term growth objectives. On October 1, we acquired mobilize, which we discussed on the Q3 conference call. On December 7, we acquired SceneDoc, which provides mobile first, SaaS field reporting for local law enforcement agencies, enhancing our public safety offerings. SceneDoc enables field capture of data, electronic notes and multimedia with secure storage and access to and from the cloud from smartphones, tablets, wearables and task specific apps, which are quickly becoming first responders' primary tools for communicating in the field.
Subsequent to year end, on February 1, we acquired MyCivic, a rapidly growing provider of citizen engagement applications. MyCivic will elevate our current citizen facing applications by enabling clients to provide a single app for citizens to interact with their local government in multiple ways. This acquisition will benefit our entire client base as MyCivic has applicability across most of our solution areas. Its unified design brings together many different user groups such as citizens, parents, public safety agencies and businesses and its mobile platform enables rapid development and deployment for clients. Most recently, on February 1, we signed a definitive agreement to purchase MicroPact Inc.
The transaction will be the 2nd largest in our history at approximately $185,000,000 in cash and is expected to close in the Q1. MicroPact is a leading provider of specialized, vertically oriented case management and business process applications for government. This acquisition augments our product solutions, positions us in new practice areas such as Health and Human Services and provides a platform to expand our business across new and complementary markets, most notably with the opportunity to significantly expand our total addressable market through MicroPact's strong federal and state presence. Now I'd like for Brian to provide more detail on the results for the quarter and provide our annual guidance for
2019. Thanks, Lynn. Yesterday, Tyler Technologies reported its results for the Q4 ended December 31, 2018. I'm going to provide some additional data on the quarter's performance and provide our annual guidance for 2019 and then John will have some additional comments. Our earnings release, we have included non GAAP measures that we believe facilitate understanding of our results and comparisons with peers in the software industry.
These measures exclude write downs of acquisition related deferred revenue and acquired leases, share based compensation expense, the employer portion of payroll taxes on employee stock transactions and amortization of acquired intangibles. A reconciliation of GAAP to non GAAP measures is provided in our earnings release. We've also posted on the Investor Relations section of our website under the Financial Reports tab schedules with supplemental information provided on this call, including information about quarterly bookings, backlog and recurring revenues. GAAP revenues for the quarter were $242,000,000 up 11.2%. On a non GAAP basis, revenues were $243,000,000 up 11.5%.
Subscription revenues for the quarter increased 26.1%. We added 81 new subscription based arrangements and converted 8 existing on premises clients, representing approximately $33,200,000 in total contract value. In Q4 of last year, we added 83 new subscription based arrangements and had 19 on premises conversions, representing approximately $44,400,000 in total contract value. The total contract value for new subscription contracts this quarter was impacted by our intentional reduction in the standard initial term for those contracts. Subscription clients represented approximately 44% of the number of new software contracts in the quarter compared to 42% last year, while subscription contract value comprised 40% of the total new software contract value signed this quarter compared to 33% in Q4 last year.
The value weighted average term of new SaaS contracts this quarter was 4.1 years compared to 5.4 years in Q4 of last year. Transaction based revenues from e filing and online payments, which are included in subscriptions, increased 6.1% to $17,300,000 from $16,300,000 last year. That amount includes e filing revenue of $13,100,000 up 4.5% over last year. Annualized total non GAAP recurring revenues for Q4 were approximately $636,000,000 up 13.7%. Our backlog at the end of the quarter was $1,200,000,000 up 1.7%.
Backlog included $365,000,000 of maintenance compared to $348,000,000 a year ago. A year ago. Subscription backlog was $480,000,000 compared to $475,000,000 last year and includes approximately $118,000,000 related to fixed fee e filing contracts. Our bookings for the quarter, which are calculated from the change in backlog plus non GAAP revenues, were approximately $248,000,000 a decrease of 13.3 percent from Q4 of last year. For the trailing 12 months, bookings were approximately $960,000,000 down 5.8%.
We had a difficult comparison to Q4 of last year, which included a $21,000,000 contract with the State of Kansas Judicial Branch. Also, as we noted earlier, the weighted average term of new software subscription agreements this quarter was 4.1 years compared to 5.4 years last year as we continue to move to standardize on shorter initial subscription terms for most of our software offerings to provide greater pricing flexibility. The change in the term of subscription rate agreements was responsible for 2.1 points of the decline in bookings. Our software subscription bookings in the quarter added $7,900,000 in new annual recurring revenue, up 11.2 percent from $7,100,000 last year. For comparison, if all of our new subscription contracts had been under arrangements, we estimate that they would have represented additional license bookings of approximately $8,000,000 We signed 46 new contracts in the quarter that included software licenses greater than $100,000 and those contracts had an average license of $371,000 compared to 48 new contracts with an average license value of $468,000 in the Q4 of 2017.
Cash flow from operations grew 32.7 percent to $70,900,000 Free cash flow, which is calculated as cash from operations less CapEx, was $66,900,000 up 39.2 percent. Our CapEx for the quarter was $4,000,000 compared to $5,300,000 last year. We ended the quarter with $232,000,000 in cash and investments and no outstanding debt. Day sales outstanding and accounts receivable was 111 days at December 31, 2018 compared to 102 days at December 31, 2017. Excluding current unbilled receivables, DSOs were 78 days at December 31, 2018 compared to 80 days at December 31, 2017.
Our guidance for the full year of 2019, which includes the estimated impact of the pending acquisition of MicroPact is as follows: We expect 2019 GAAP revenues will be between $1,080,000,000 $1,101,000,000 and non GAAP revenues will be between $1,090,000,000 $1,110,000,000 We expect 2019 GAAP diluted EPS will be between $3.54 $3.69 and may vary significantly due to the impact of stock option exercises on the GAAP effective tax rate as well as the final valuation of acquired intangibles. We expect 2019 non GAAP diluted EPS will be between $5.20 $5.35 For the year, estimated pretax non cash share based compensation expense is expected to be approximately $62,000,000 We expect R and D expense for the year will be between $82,000,000 $84,000,000 Fully diluted shares for the year are expected to be between $40,041,000,000 shares. GAAP earnings per share assumes an estimated annual effective tax rate of 10% after discrete tax items and includes approximately $27,000,000 of estimated discrete tax benefits, primarily related to share based compensation, which may vary significantly based on the timing and volume of stock option exercises. Our estimated non GAAP annual effective tax rate for 2019 is 24%. We expect our total capital expenditures will be between $54,000,000 $56,000,000 for the year, including approximately $16,000,000 related to real estate and approximately $6,000,000 of capitalized software at MicroPact.
Total depreciation and amortization is expected to be approximately $75,000,000 including approximately $47,000,000 of amortization of acquired intangibles. Now I'd like to turn the call back over to John for his further comments.
Thanks, Brian. The 4th quarter continued the elevated level of investment we exhibited throughout the year. The strength of our balance sheet and consistency of our cash flow gives us a great deal of flexibility to deploy capital and create long term value. At a high level, in 2018, we invested a total of $391,000,000 in cash on acquisitions, R and D and stock repurchases. The purchases of Mobilize in October and SceneDoc in December brought us to a total of 5 acquisitions completed in 2018 for a total cash consideration of $178,000,000 While these acquisitions further the objectives that Lynn mentioned earlier, expanding our TAM, strengthening our product offerings, providing cross selling opportunities and advancing our Connected Communities vision, we're also making incremental investments in those businesses.
Those investments include accelerated R and D, particularly at Socrata, as well as investments in operating expenses 2019. We believe those investments, while putting pressure on short term operating margins, will contribute to future revenue growth and margin expansion. As we discussed at the beginning of the year, we also significantly increased our R and D spend organically. Total R and D grew 34% in 20 18 to $63,000,000 with a wide range of product development projects across our product suites. While R and D expense will grow organically at a slower rate in 2019, this year will still be a year of elevated investment in product development.
With R and D and acquired companies, including MicroPact, we expect total R and D to grow in the 30% range in 2019. Finally, we were very active with our stock repurchase program in the Q4 as we bought back almost 781,000 shares of our stock for a total of $150,000,000 That amount exceeded the total amount we spent on buybacks in the last 6 years combined, reflecting our confidence in the long term outlook for Tyler. Over the last 15 years, we have taken an opportunistic approach to our stock repurchases and have been particularly aggressive several times when the stock has pulled back 15% to 20% as it did in the 4th quarter. In hindsight, it has shown these strategies to be effective. In addition, our Board has added 1,500,000 shares to our buyback authorization, which now stands at 2,700,000 shares.
Although our current investment cycle has put pressure on margins, we are confident that our long term model of low double digit total revenue growth, consistent margin expansion and strong earnings and cash flow remains in place. Now we'll take your questions.
We will now begin the question and answer session. And your first question will come from Brent Bracelin of KeyBanc Capital Markets.
Thank you and good morning here. One for Lynn and one for Brian, if I could. Lynn, I wanted to start out with a question about the business as it matures and scale to this $1,000,000,000 kind of level. You're addressing, I think, a $14,000,000,000 TAM. My specific question is around the white space initiative.
As you get to this $1,000,000,000 scale, how much room is there to continue to kind of grow faster than the 5%, 6 percent kind of growth rate of the market? How competitive is the opportunity? And as you think about 5 acquisitions in 2018, do you think that's kind of the right piece to continue to sustain above market growth long term in given the size of the business and scale? Thanks.
Yes, sure, Brent. Thanks for the question. Yes, I think as we look out over the near term, 3, 4, 5 years, internally, we believe that we can continue to grow faster than the overall rate. Acquisitions have certainly played a part of that over the years. And really, when we look at the acquisitions we did in 2018, on some level, I call those somewhat investment acquisitions.
These are things that we're buying. We're going to bring them in. We're going to invest in them. And really, the ultimate goal is to provide and prompt higher growth rates than perhaps other parts of our business. You asked about the white space initiative.
The white space initiative is where we identify things like some of the acquisitions that we brought in. It's also one of the reasons why we, in 2019, made the decision to buy MicroPact, a company that obviously moves us into new markets, gives us the ability to grow into new addressable markets. So that's something that we've looked at very carefully. Helpful.
And then I guess, Brian, if I just look at the e filing business, this quarter 6% growth down from 16% prior quarter and 22% last year. I continue to think of about e filing as an emerging market. So little surprised to see kind of the single digit growth there. Walk us through the dynamics around e filing, the slowdown there you saw in Q4 and then the
I think two things. 1, the sequential slowdown is really a seasonal impact. There is simply in the Q4, particularly in December, around the holidays, there's less activity in the courts, less filings taking place and to the extent that a large portion of that business is transaction based with a per filing fee that affects that's a normal impact we see in Q4. You may say you look back at last year and you didn't see that. It was sort of covered up last year by some new clients that came on board that provided growth that offset the seasonal sequential drop.
This year, we didn't really have any new clients coming on in the last quarter. And we do believe that that's a market that is still has a lot of white space, a lot of runway there that a large portion of the e filing market or potential e filing market in the U. S. Is in a market that we believe is close to $300,000,000 a year. We think that less than half of that market is currently penetrated and we expect that over time we'll continue to add new e filing clients.
But again, it's somewhat lumpy. We actually do have a reasonable pipeline of, I guess I'd say pipeline a bit of a backlog of e filing arrangements that will come online once an underlying court system goes live. But as I said, the timing of those is somewhat lumpy and we just didn't have any new ones come on this quarter.
I realize you also asked about the pace of the acquisitions in 2018. It was a year of significant activity. I wouldn't say anything specifically drove that. The white space initiative has always identified things. We constantly evaluate potential acquisitions.
It's something we've done in the 20 years I've been at Tyler. If you look out over the 20 year history, we've done probably 40 ish plus acquisitions. It just happened to be a year where a lot of things lined up. We saw a lot of good opportunities. We were able to make good fair deals.
We've gone through a couple of years where it was very hard to make a fair deal. We've talked before about a lot of money coming into our space from the private equity world and things like that. Bringing those acquisitions in is a stress on the organization, and we've talked a little bit about in the last year about our Elevated Plus, about our Elevated Investments, and you hear me talk about these as investment acquisitions. We've got a lot going on, on our plate right now. And our focus right now is to really execute on all these investments that we're making.
Makes sense. Thank you.
The next question will come from Peter Heckmann of D. A. Davidson.
Good morning. Thanks for taking my question. Could we dig in a little bit more on the bookings for the full year acknowledging that there have been some large deals that occurred in prior year periods that may be exacerbating kind of the optics of softer bookings. But can you get into a little bit more detail on deal slippage, perhaps any change in the sales force or sales force comp that may be affecting bookings? And then as well, any change in competitive dynamics or demand drivers?
Just again, and a part of it is optics, but clearly bookings were softer in 2018. And so I'm just trying to figure out what are the factors that factored into that? And then what's your outlook for this year? I mean, can we catch up on those deals and then put up a relatively stronger bookings year in 2019?
Yes. Well, certainly, as you note, bookings, particularly with respect to large deals, can be somewhat lumpy and I'd say that's probably the biggest factor this year in the lower level of bookings. We had several large deals, a couple more what we describe as more mega deals like a statewide courts deal, the Illinois e filing research deal that took place last year. Those are typically multi year deals. So those revenues get continued to we continue to work out of that backlog.
Even just in this quarter, if you look at it was a really good quarter for our sort of our bread and butter midsized deals. But if you looked at the top 10 deals, top 10 license deals plus the top 10 SaaS deals this quarter, those totaled $35,000,000 last year, those top 10 or top 20 deals totaled $70,000,000 So it really shows the impact of the large deals in there. I don't think there's anything fundamentally that's changed either in our sales organization or sales compensation. In the market dynamics, the competitive landscape generally is pretty consistent with where it's been. There's certainly been some activity in terms of acquisitions and consolidations among some of the other players in the space, but don't believe those have negatively impacted us and in some cases positively impacted us.
There were the timing of deals particularly in the public safety space continues to be a little less predictable. And some of these are complex deals with multiple jurisdictions involved. And because a lot of that business is concentrated in the Q4, with Public Safety in general, we had a good quarter for awards, but we had a fairly large number of deals that certainly had the possibility of closing in the Q4 that have slipped out of the Q4 and several of those have closed already early in the Q1. Variety of reasons around those, so no systemic cause, but in a sense it just goes with our market. We do expect that, you can see based on our guidance, based on the activity in the space that we would and again coming off a year with not really strong bookings that we'll see better growth in bookings next year.
And the last point there really is that we do have an increasing number of revenues that don't really come in, in terms of a single contract. So more of the recurring revenues, things like Modria, our online dispute resolution solution that solution that are transaction based. And so there's not a big contract at the front, but the revenues the bookings hit as the revenues hit. And to the extent those are a greater part of our revenue base, you don't see them show up in upfront bookings. And then we of course pointed out the impact of the shorter term on subscriptions that also negative doesn't affect the annual revenues at all, but affects the optics of the booking number.
Got it. Got it. And then just as a follow-up, you're just looking at R and D and non cash stock compensation, last 3 years both have out stripped revenue growth. I think you've talked a little bit about the R and D. Is the stock comp just a reflection of the current environment for hiring, the current employment environment or are there higher skill sets you're trying to achieve?
It's really just the way that's accounted for. So you account for the stock options on a Black Scholes method and the volatility and the elevated price of our stock raises the amount that you actually expense. We're very, I think, conservative in the way we award options and now restricted units as well. The total units awarded has come down over the years as a percentage of outstanding fully diluted shares. Total units is just fractionally above 1% now.
And when you consider that on a net basis or after proceeds from stock options and the tax benefit, it's under 1%. So, this is not a case of us awarding additional options or restricted units. The absolute number and the number as a percentage of outstanding shares is something we track very, very closely and it's actually come down over the years. It's just a function of the way the accounting is calculated.
That makes sense. Thanks for the color.
The next question will come from Alex Zukin of Piper Jaffray.
Hey, guys. Thanks for taking my question. So maybe just starting on the guidance. I think is it possible, Brian, to get a sense for what the expectations are for MicroPact that are embedded in the guidance? And can you speak to maybe how should we should be thinking about the growth of MicroPact in 2019 and also maybe the implied organic growth guidance that you provided?
And I've got a quick follow-up.
Sure. And besides MicroPact, there are the tail of several other acquisitions, including Socrata for the Q1 of the year that were made in 2018 that are included in the inorganic growth in that number. We've said MicroPact's revenues for the last year were a little north of $70,000,000 somewhere between $70,000,000 $75,000,000 It has been in the last year a low single digit grower. We do expect that growth to accelerate over time, but our expectation in the 1st year is that it will be pretty modest growth. And the midpoint of our guidance would imply organic growth in total of, I'd say in the 8.5% to 9% range and again relatively modest growth on MicroPact in the 1st year.
We do believe MicroPact will be neutral to modestly accretive in terms of earnings. So it's but the 20 18 acquisitions in the aggregate are continued to be dilutive in 2019.
Got it. And then maybe just a quick follow-up, a 2 part question. If you think about the organic growth guidance for 2019 and you think about the backdrop of the demand environment, the competitive environment, the increased acquisitions that you've done. Can you maybe just give us a sense for the level of conservatism in that guide and what could drive outperformance there? And then the follow-up would be for John, as we think about returning to kind of an returning to an ability to actually see margin leverage again not in fiscal 2019, is that presumably a fiscal 2020 event or is it even great further in the future than that?
Yes, I will start with the factors in the guidance. I don't think our philosophy has changed. We generally try to be realistic in our guidance relative to our plan and take into account what is a reasonably likely range of expectations in terms of opportunities and risks that are embedded in there. Again, as in the last couple of years, probably the biggest factor in where we fall in that range is the mix between license and subscription in the new business market. And we see as our revenues have grown, we've widened the range a bit in terms of our initial guidance and we typically narrow it as we go through the year.
But because so much of our revenues now is recognized upfront on a license deal and certainly over time on a subscription deal, it has a pretty significant impact as you know how that mix falls out. So that would be the biggest certainly timing of deals as well. We have pretty consistent win rates. But once we win a deal or awarded it, sometimes there are a lot of factors, particularly as we get into more and more larger deals that make the timing of ultimately signing it and recognizing it a little less predictable. And we've seen that particularly in the 4th quarters in recent years.
The second half of the question regarding our elevated spend on R D and other investments is certainly a very good question. As we mentioned in our prepared remarks, the cash flow characteristics of the company are both very good and very predictable and high visibility. And we certainly spend a lot of our time on how we want to deploy that capital. And we've talked a lot about acquisitions, which we were successful on executing on in 'eighteen and already off to a pretty strong start here in 'nineteen. We're active again in our repurchase program.
And kind of the 3rd leg of that stool is the organic investment in the company internally, which has been elevated as well. Obviously, the difference in those spends are the organic investment for the most part, virtually all of that is expensed through the P and L and it's elevated. So it's a drag on earnings, whereas the other 2 are just seen as investments. These are important investments. We've got the capital to deploy, investing in our products, widening the moat and protecting ourselves against the competitive threats out there are things we feel strongly.
And in fact, I think it's something we probably do better than the other 2. We compete with a lot of PE owned assets, a lot of financial owned assets that can't necessarily just invest in products and build new products. That's what we do. We do it well. We have pretty good certainty on the outcomes.
And so I think we have a strategic advantage and we'll continue to do that. The last couple of years have certainly been elevated beyond what we would have expected. That's a reflection of the opportunity we've seen in our products and we think it's a good investment to make, although again, it's elevated relative to expectations we may have set. My My expectation would be that this would normalize, that we would grow into the current R and D spend. I don't see the absolute dollars coming down.
I see us growing into it and therefore the margin is expanding. But I'd be cautious to say that it will happen later in 2019 or 2020 because if those opportunities are there, we'll fund them. And we certainly don't want to restrict it ourselves. But my expectation would be that, yes, later this year into 2020, more than likely, we'll start to see that normalize and see the margins accelerate again. But again, if we see valid opportunities for further investment, then we'll certainly fund those.
Lynn used the phrase a couple of times on the call, acquisition investments, which I think what we mean, we acquire companies and then we invest in them. And the focus usually are on the acquisitions we did last year or the year before, Socrata or these deals, which are not yet real constructive in terms of their contribution within the company. But if you look back a few more years and you look at names like Executime or Brazos or Wiznet, which became our e filing product or Brazos, names that have kind of faded, they all have revenues that are multiples of what their revenues were when we acquired them and margins that are probably at least double what they were when they acquired them. And that's kind of the model. So we're in an investment cycle now.
We have a record of both the inorganic and organic investments paying off. We are in a high investment cycle. We expect to grow into that over the next 18 months or so. But again, we're not shying away from the investment opportunities. We're actually looking for them.
And when they're valid and credible, we'll continue to fund them. So I appreciate that that's a little uncertain, but that's the way we look at things.
Thank you, guys.
Next, we have a question from Scott Berg of Needham and Company.
Hey, guys. This is Josh Reilly for Scott Berg. So just starting off here, how are you thinking about going to market with MicroPact once the transaction closes? How do you plan to cross sell that product into your existing customer base? And then can you talk about how the acquisition expands your TAM and what your thoughts are with the opportunity to expand into the federal market?
Thank you.
Yes. Hi, Josh. Good questions. MicroPact has got a pretty extensive sales force in their markets. They also have been fairly successful with a
partnership model.
They've been developing that for a something that we have not historically done. It's they're starting to see some traction with that and some success. I expect them to continue to sell in their market the way they have historically sold and expect that over the coming years, we'll learn some competencies from them. In terms of cross sell, I don't believe there's any necessarily immediate cross sell opportunities. I do we have products that will certainly play in the space that they play.
Good example, Socrata, they're already in the federal space, already in a lot of these agencies where they're at, and I'd expect those opportunities to arise. I'll let Brian talk
a little bit about the TAM that we've seen with MicroPact. Sure. MicroPact focuses on the case management, which is their interpretation there is much broader than our historical interpretation where we focus on court case management, but broadly case management and business process management. That market, we believe in total is about an $8,000,000,000 market in the U. S, of which about $2,000,000,000 is in the government sector.
So that's really the TAM expansion that we see immediately from MicroPact. So that's not at all in our space. And about roughly half of that, about $900,000,000 of that government TAM is in the federal space and about $1,100,000,000 is in the state and local space. And that really is the expansion that we get immediately from the MicroPact acquisition.
Great. Thanks, guys.
And next we have a question from Rob Oliver of Baird.
Hey, great. Thank you, guys. One for Lynn or John to start and then Brian, a quick follow-up for you. I just wanted to step back a little bit and I know at the beginning in response to Brendan's question, you guys talked about the white space initiative. But I just wanted to understand a little bit better just the thought process and rationale about the expansion into federal.
Obviously, you guys really dominate local and municipal. Federal is a much more competitive area and with a lot of embedded players and MicroPact is a software solution, which it looks like can be leveraged across multiple areas and likely potentially on the HHS side into your core base as well eventually, I'd like to hear about that. But just wanted to just step back and maybe get your thoughts on this move with Socrata and now Microbect into federal?
Sure, Rob. And I guess I want to caution, while they do a significant amount of business in the federal space, there's not limited to the federal space. They also play more at the state level, where we're not really active. While we have some statewide engagements, we don't really play at the state agency level. I would say that historically over the years, we've looked at both the federal and the state market as something of interest to us.
It's adjacent to our market. But frankly, we've never really found the right opportunity to make the move in that market. When we looked at the company like MicroPact, and again, we've looked at a lot of companies over the years, when we looked at a company like MicroPact, it looked a lot like Tyler, it looked a lot like the kind of company going back 20 years ago when we would maybe go into a new space, whether it be moving into appraisal and tax or in the court space or whatever, we were looking for sort of a flagship company, good solid revenue base, good products, but most importantly, really good strong management team, a team with a culture that's very similar to Tyler. We take moving into a new space very seriously and not something that we would certainly dip our toe in lightly, which is why we've really sort of waited for the right player. MicroPact checked all those boxes.
We spent a lot of time with these people, really got to understand the market, understand the things they do well. We believe it's a really good complementary fit. I do believe long term there are some other opportunities, as you mentioned, Socrata as well. But I think it's just a natural extension. We're still focused on public sector.
That's what we've always done. We believe they've done a great job in the federal space as well as the state space. I think what's interesting about them as well is that they're when we looked at companies in the past, they've tended to be a more project oriented as opposed to product oriented, and that's certainly away from our business model. The fact that they are a product oriented company also really aligns with our underlying business model. So we saw those synergies, and we think it's going to be good long term.
Great. Thanks, Lynn. Appreciate it. And then Brian, just a quick follow-up for you. I know you've mentioned throughout the call just some of the impact or headwinds from the shorter durations, impact of bookings from shorter durations and just wanted to get a sense for there's likely a positive at the other end of this with some more flexibility on price for you guys and just wanted to talk a little bit about what you're seeing on the pricing side and kind of what you expect to see play out there on the shorter durations?
Thanks.
Sure. Yes, with our software subscription arrangements, typically those contracts are very often they are a fixed annual fee for the initial term. And so there's not even though in the economics there may be embedded annual increases that are averaged out to get a level of annual payment and therefore level of annual revenue recognition there. They effectively don't show growth during that initial term. So we have a chunk of revenues with each of these contracts that doesn't grow until it gets to the end of the initial term.
And then we expect that generally that we would have increases that are similar to the kinds of increases we get in maintenance, low to mid single digit annual increases that encompass an increasing level of features and functionality that they get through that evergreen model that we deliver our software under. So it does a couple of things. It shortens the period in which that we have that no growth revenues and gets us on a regular cadence of increases more rapidly and provides us with long term flexibility that we're not locked into pricing for 5 years or 7 years when there could be uncertainty over our costs over that period. So you're correct that as our older longer term subscription arrangements roll off and we get on a cadence of more regular increases in that base of revenues, it should go from a headwind to revenue growth to providing a benefit to our annual revenue growth.
Thanks, Brian. Thanks, guys.
The next question comes from Jonathan Ho of William Blair and Company.
Hi, good afternoon Or good morning rather. I just wanted to maybe dig in a little bit in terms of how you see the opportunity to maybe accelerate the growth around Micro Focus. Is this a function of investing more in the product? Are there other things that you can do? And what do you ultimately see as sort of the ability to, I guess, invest in Micro Focus just based on what you've seen today?
Yes. Thanks, Jonathan. As we mentioned, we will continue to invest in MicroPact. They have been going through a little bit of a replatforming of their product, and I believe and it's shown well. It's already been sold.
It's out in the market. It's doing really well. I think as that product continues to become more robust and more configurable, it will help accelerate growth. Like we said, they've been working on a partner network for a number of years that is starting to bear fruit. They have some international opportunities that are coming out of that partner network.
So I think the market is good. Their position in the market is good, both in the federal and the state, and we see it as a good growth driver down the road.
Got it. And then just in terms of the follow-up, I guess, when we look at sort of the duration impacts to bookings in 2018, Do we expect there to be further, I guess, reduction in the duration in 2019? Do we just sort of lap the current effects? I mean, I just want to get a sense of how that will extend from the 2018 to 2019 timeframe?
I think there's probably a little impact ongoing. There's a mix of and we really kind of put the new standard terms in place in the Q1, but you have proposals out there already of contracts in process. And so it takes a little while before you've sort of fully rolled it out. We certainly have some contracts that are longer than that, longer than the standard 3 year initial term. We have some that are shorter.
In some aspects, we have 1 year subscription arrangements. So I think it will continue to sort of sort itself out. I don't think it will be as dramatic. We seem to be settling in closer to this 4 year average term. But I think because we didn't really start it with a hard start on January 1st, there will be some continued impact until we settle in at the level that we will ultimately be at.
Thank you.
The next question will come from Keith Housum of Northcoast Research.
Good afternoon, guys. This is Brendan on for Keith. Guys, I just want to ask a quick question about the New World product. You mentioned before you were thinking about how to upgrade the capabilities to target the Tier 1 space. And we're just wondering if there's an update on how far along you guys are in those efforts and anything specifically that you had to do to upgrade the product?
Thanks.
Yes, Brendan. I mean, we're continuing to invest in the New World products. I guess the short answer is, is that those investments are paying off. We've seen significant product adoption, in our sales this year, both across the board in CAD records and our Patriot or Mobility, we see increases in our pipeline right now. They're up significantly year over year.
We talked earlier about some deal slippage. That's kind of the good news. Bad news about what we've been doing is we've actually been expanding our market. We've been expanding the pipeline, so there were greater number of deals that we were trying to chase in Q4. It's an evolving process, just like a lot of development efforts, but we're continuing to invest.
We continue to make progress. I don't think it's something that you say overnight. Now we're there. That's not sort of the way the R and D works. We keep investing and we keep growing the TAM.
I think the key is back when we acquired New World and as we went into 2017, So 2 years ago, we launched a couple of major development efforts with respect to public safety aimed at both adding features and functionality and separating ourselves from the other competitors in our traditional mid market space, but also adding that functionality that we needed to compete effectively at the upper end of the market. And those projects are well along and we've had releases along the way. We've certainly seen impacts very positively on the win rates in our traditional mid market space. And I think we're just now getting to the point where we think that we have the ability now to actually check off the boxes in larger opportunities and say, yes, we have we meet those requirements. But having said that, the timeline is long.
So if we respond to say an RFP and a larger opportunity early in 2019, That decision may not be made until late 2020 given the length of the sales cycles and they are longer and larger deals. So you could it could really be 2021 before you start to see real awards and revenues from those upper tier customers literally 4 to 5 years after we launched the development projects. So this is a space that requires patience that we have and we see progress along the way that we're very pleased with, but actually seeing it show up in financial statements is a long prospect.
All right. Thank you. Appreciate the color.
Our next question comes from Kirk Materne of Evercore ISI.
Yes. Thanks very much. John, I appreciate sort of your color and sort of around M and A and sort of the philosophy on that. I was wondering if you could just give us any color, you and Lynn could give us some color actually on what you guys think about sort of from a return perspective on M and A, meaning as you stack these deals on top of each other, we don't necessarily get to see the kind of return New World had from a profitability perspective. And given how fragmented your market is, I would think there's almost a never ending opportunity for you all to do M and So how do you think about getting the right return on prior deals before going into a new one?
I'm sure there's some thought process there, but if M and A is going to be a more regular part of the dialogue, it'd just be helpful to have some color on that front.
Yes. It varies based on the types of deals we're doing. As we've said, in recent years, we've really shifted largely away from consolidation plays, which really was more of an intrinsic valuation approach and return on the assets you're purchasing the way you might think. So we're very disciplined in that case, multiples of EBITDA and sales and what they might do for us and discounting the cash flows further out and kind of a traditional approach to that. There aren't a lot of significant consolidation plays out there doing very small.
There's a lot of $3,000,000 $5,000,000 $8,000,000 companies with 60% of their revenues are recurring. That's the book you're buying. And there just isn't a lot of that. There's a lot of PE firms and even a couple of public firms that target those. So we really moved away from those, which really employed more of the traditional return on investment approach that you're alluding to.
I won't say we're not disciplined. I think we've always been disciplined and certainly lose out on some deals because of that discipline. But we've certainly, I guess, loosened a little bit our model on strategic acquisitions, especially smaller strategic acquisitions. So I mentioned Executime earlier, probably few of us even remember that acquisition from a number of years ago, very small, a few $1,000,000 in revenue. We bought it at a reasonable price point.
But the reality is, when 5 years later, those revenue start to accelerate and their revenues are several times what they were acquired at, the margin starts to expand because of scale, they've improved the competitive position of your other products in those areas like Muzus and Encode. You could say it almost doesn't matter too much how much you paid for them initially. So, it's a difficult thing to quantify on the strategic side. And I would say, Wiznet, we paid $10,000,000 for that. And it's obviously our e file opportunity products are worth 100 and 100 of 1,000,000, maybe you could argue $1,000,000,000 in our total segment of our total market cap.
So those are the deals we're looking for and that's the way we look at it. That 5 6 years out, when they hit scale, when they're growing at a good rate, when their margins are Tyler like and then you back into what their proportionate valuation within Tyler's $8,000,000,000 market cap is, they're very, very compelling. And those are the deals we're looking for. That's why we invest in them in those early years after we acquire them, and we're looking for that kind of a return down the road.
That makes a ton of sense. I guess the question is, is this just over the next 3 to 5 years given the opportunity in front of you, the operating margin sort of expansion story. I think longer term that seems to still make sense, but it seems like in the near term, maybe call it 3 to 5 years, if this is going to be more of an investment mode for you guys, operating margin is a little bit secondary to getting the right assets and the right portfolio put together. Is that fair?
Maybe, but you're going to have a hard time getting our management team to we really we work real hard to support these investments. And I'll be honest with you right now, appreciate the market likes investment. You follow a lot of companies that aren't that focused on margins, some aren't even profitable and are highly valued. We're really not culturally that kind of company. So for us to support those investments, we really have to be convinced and have a high level of confidence that it's going to pay off.
We've referred to this as a cycle. I think we're in a high investment cycle right now. There are a number of opportunities in our own core products as well as these acquisitions we've done and the incremental investments that should be made in order for them to realize their potential that we're supporting. I think that cycle will cycle out and will be in a period of time. So right now, ideally, you'd have the right balance all the time, whatever it is, 80% have reached some level of maturity, they've reached scale, the margins are expanding, etcetera, etcetera, and you've got the right level of investment organically and inorganically.
Right now, we've got a higher percentage of that in the investment mode and that's putting some pressure on margins. I think that pendulum will swing back and forth and will return certainly to an expanding margin situation. I took exception to one word in the script that said consistent margin expansion. Well, that's not really what we have. I think over the long term, we have certain margin expansion, but it is a little inconsistent.
That's really helpful. And then if I could sneak one in for Brian or for all of you. Just on the buyback, obviously, with the MicroPact acquisition, they'll draw down some of liquidity. Would you all go into a sort of debt position to fund the buyback if the situation sort of unveiled itself? I'm just kind of how I guess how bound are you by sort of your cash balance as it relates to your buyback?
Thanks.
Yes. I think Peter the or Kirk, the answer is absolutely yes, we would, depending on the opportunity. If you look at our history, we've done it before. We did it 6, 7 years ago. We took out a line of credit specifically to buy back stock and tap that line to do so.
So the good news is we do experience good cash flow. Our cash flow is fairly certain and predictable in the out years. We take that into account when we look at all of our investments, including acquisitions and stock buybacks. So we're certainly not we wouldn't be timid if the market opportunity was there. So we like I
said, we've done it in the past.
Yes, you can look back
to
early 2016, the last time we were really active in that first part of 2016 and we had some debt on the balance sheet following the New World acquisition and we used more debt to buy stock back when we thought there a more compelling opportunity in the short term. I don't think we'd ever be what you described as heavily leveraged for buybacks, but we're not opposed to using debt if we see the opportunities compelling enough.
Great. Thanks for answering my questions, Adam.
Just to add on to those, so Kurt, we've done in the past, as Brian and Lynn both indicated. We certainly would be comfortable. We maintain a working capital line now, so we have plenty of access to capital. But we also know the kind of investors we attract investing in quality companies and part of that is a strong balance sheet. So I think as Brian said, we would never be over levered and I think more than likely debt wouldn't occur to do an acquisition to repurchase our stock or whatever investment we felt was compelling enough to support would be pretty much on a temporary basis that a permanent debt situation is unlikely for us.
Thanks, gentlemen. Appreciate it.
Our next question comes from Peter Lowry of JMP Securities.
Great. Thank you. Two quick questions. First, of the several slipped public safety deals that have closed subsequent to Q4, is that a pace that is encouraging, discouraging or neutral at this point in the year? And then second, can you remind me the mix of which revenue line items the MicroPact acquisition will show up in?
Thanks.
Yes, sure. I think it's probably neutral. The timing of their deals weeks, we had been awarded going into the Q4 or were awarded in the Q4. Some of those get and that really happens every quarter. We have deals that flip for a variety of reasons.
There are a lot of factors around doing business with public sector even down to when is that last council meeting and does the city attorney get it on the agenda? Are you able to round up all the signatures in time? And sometimes the urgency isn't there on the client's part and those deals slip. We see that a lot of times where in the Q4 though where public safety has a bigger proportion of its business, it has a bigger impact. And but I don't think it particularly changes our plan this year.
We'll likely see the same scenario next year in Q4. And so I'd say it's relatively neutral. The MicroPact revenue mix, their business is actually their mix is fairly similar to the Tyler mix. They're about I'd say their plan for this year is somewhere around 17% of the revenues are licenses, about 30% services, a little bit heavier on services, 10% subscriptions, low to mid 40s, 43% say maintenance. So not too dissimilar from Tyler's current mix.
Yes, Peter, on the public safety deals, I think when this happens all the time up and down our market and we have lots of divisions where deals come in, deals go out. For public safety, I think as the volume of deals is what we've been talking about last couple of years as their win rates go up, the volumes going up, the number of deals in their pipeline, I think you'll just start to see some of that balance out to where when deals start slipping, they naturally start getting sort of funneled back on the other side. And I would expect that as you look out over time, you'd have less of this sort of discussion or focus on that.
Great. Thank you.
The next question comes from Mark Schappel of Benchmark.
Hi, thank you for taking my question. Brian, a question for you on the Public Safety business, kind of a follow-up to the prior question. But this business has kind of had its ups and downs here. And I was wondering if you could just give us some ideas of some of the changes you're making in that business with respect to your go to market activities as well as maybe product development to try to get that business to perform a little better?
Well, I think over the time since we have acquired New World, we've made some changes in their sales organization. We have some different sales leadership there. I think we've aligned some of the sales processes more closely with the way Tyler has historically done things. But they're executing very well. I mean, the win rates have basically doubled since the time we acquired them to where they are today.
I think that's a combination of the investments we've made in the company organizationally, the support organization, the sales organization. Certainly the investments we're making in the product are clearly having an impact on the market. That roadmap and those things that we've released along the way. And I think the Tyler brand, the integration with other Tyler products, particularly our Courts and Justice, Softcoat, Brazos, all of those things have a positive impact on there. So it is a market that is highly competitive.
It's a market that also is a little more seasonal in terms of the activity towards the latter part of the year. But I think we're pleased with the progress we've made with the execution in that division. And I think some of this just sort of short term inconsistency will play out and this is going to be a business that over the longer term grows faster than Tyler's core business. Right now, that's not the case. But we as we've talked about some of these other investments where we make investments in acquired companies and it's a multi year process to see those pay off.
As we look at the milestones that we've accomplished along the way, we feel very good about where the Public Safety business is today.
At this time, there appear to be no more questions. Mr. Marr, I'll turn the call back over to you for closing remarks.
Okay. Thank you. And thank you all for joining us on the call today. We appreciate your interest. If there are any further questions, feel free to contact Lynn Moore, Brian Miller or myself.
Thanks again. Have a great day.