Tyler Technologies, Inc.
Q1 2008 Earnings Call Transcript

Published: 24 Apr 2008

[Operator:]

Please stand by, we are about to begin. Hello and welcome to today’s Tyler Technologies first quarter ‘08 earnings conference call. Today’s call is being recorded. Your host for today’s call is John Marr, President and CEO of Tyler Technologies. Mr. Marr, please begin your call.

[John Marr:]

Thank you, Jason and welcome to our first quarter 2008 earnings call. Joining me from our management team is Brian Miller, our Chief Financial Officer. First I would like for Brian to give the Safe Harbor statement then I’ll have some preliminary comments, Brian will review the details of our operating results, then I’ll have some final comments, then we’ll take your questions. Brian.

[Brian Miller:]

Thank you, John. During this course of the conference call management may make statements that provide information other than historical information that may include projections concerning the company’s future prospects, revenues, expenses and profit. Such statements are considered forward-looking statements under the Safe Harbor Provisions 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 would refer you to our Form 10-K and other SEC filings for more information on those risks. John.

[John Marr:]

Thanks, Brian. The first quarter of 2008 marks Tyler’s 28th consecutive profitable quarter. Overall results for Q1 were in line with our expectations for revenues and margin growth. Organic growth continues to be in double-digits and was supplemented by recent acquisitions. We also saw solid growth in software services and maintenance. Free cash flow was $16.9 million, exceptionally strong. To be at this level there were contributions from throughout our business. But in particular it was driven by favorable billing terms on certain large contracts. We continue to invest in growth with increased research and development spending on our new Microsoft Dynamics Development effort as well as other new and existing product development efforts. Even after investing more than $24 million in cash in acquisitions in the repurchase of our own stock during the period, we ended the quarter with a strong balance sheet, including $46 million in cash and investments, providing Tyler a high degree of financial flexibility. The acquisitions of Versatran, Schoolmaster and ASP also closed since the first quarter of last year, resulted in 5.6% revenue growth, break-even GAAP earnings and positive EBITDA and free cash flow. Now I would like for Brian to offer some comments on the details of the financial statements. Brian.

[Brian Miller:]

Thanks, John. Yesterday, Tyler Technologies reported its results for the quarter ended March 31st, 2008. For the first quarter of 2008 Tyler had revenues of $59.4 million, up 17.9% from the first quarter of 2007. Our organic revenue growth for the quarter was 12.3% and acquisitions since March 31st of 2007 accounted for 5.6% of our revenue increase. Operating income was $4.7 million, up 34.3% from $3.5 million for the first quarter of last year. Net income for the quarter increased 30.2% to $3.1 million or 8 cents per diluted share compared to net income of $2.4 million or 6 cents per diluted share in the first quarter of 2007. Free cash flow was exceptionally strong in the first quarter. Cash flow from operations was $17.8 million for the first quarter compared to $6.9 million a year ago. Free cash flow was $16.9 million; nearly triple the $6.1 free cash flow for the first quarter of last year. The increase in free cash flow was primarily driven by an increase in deferred revenues resulting from cash received from advance payments ahead of revenue recognition on certain large contracts which have favorable billing terms. While we have revised our annual guidance for free cash flows modestly, the timing of cash flows can be difficult to predict, particularly from quarter to quarter. EBITDA for the first quarter of 2008 was $7.6 million compared to $6.1 million in the first quarter of 2007. A reconciliation of GAAP income to EBITDA is included in our earnings release. Our software-related revenues, which includes software licenses, subscriptions, software services and maintenance increased in the aggregate 23.1% over the first quarter of 2007. Software license revenues increased 5.5% over last year`s first quarter. Software license revenue related to our financial management and education product, which comprised 71.1% of our software license revenues, increased 15% primarily due to revenue from student information and management solution and student transportation management solutions acquired in the last 12 months. Quartz and justice licenses increased 5% over last year`s first quarter. These increases were partially offset by a 32.4% decrease in appraisal and tax and other software licenses due in part to the deferral of software license revenue on a customer arrangement pending revised timelines for completion, as well as a small number of land records customers choosing our subscription-based options. Subscription revenues increased 45.4%, primarily due to the addition of new, larger ASP customers in the last half of 2007 as well as an increase in disaster recovery customers. During the first quarter we signed one new ASP customer, Westport Connecticut, for our financial management product and converted three existing MUNIS customers to our hosted offering. Software services were up 27.6% from last year`s first quarter and maintenance revenues grew 24.6% from the first quarter of 2007. Appraisal services revenues for the first quarter decreased 17.9% from the first quarter of `07, primarily because we substantially completed projects associated with the Ohio revaluation cycle as well as other appraisal contracts. We currently expect appraisal revenues for the full year 2008 to decline moderately compared to 2007. The revenue mix for the first quarter of 2008 was as follows. Software licenses 14%, subscriptions 5%, software services 28%, maintenance 42%, appraisal services 8%, and hardware and other 3%. For the first quarter of 2007 the revenue mix was licenses 16%, subscriptions 4%, software services 26%, maintenance 40%, appraisal services 11%, and hardware and other 3%. Overall 89% of our revenue mix was software-related in the first quarter of `08, up from 86% in the first quarter of 2007. For the first quarter of 2008, our overall gross margin improved 90 basis points to 36.7% compared to 35.8% in last year`s first quarter. Sequentially, gross margins decreased from 40.4% in the fourth quarter of `07. The increase in blended gross margin from last year`s first quarter was due to leverage and the utilization of our support and maintenance staff and economies of scale as well as a revenue mix with less appraisal services revenue. The sequential decrease in the blended gross margin from the fourth quarter of 2007 is primarily due to lower software license revenues in the mix for the first quarter of 2008, which is a typical seasonal trend. Software license margins for the quarter were down slightly from last year at 68.5% versus 70.3% last year. The decrease is primarily due to the license product mix this year that included more third-party software which has lower margins than our proprietary software. The blended margin for software services, maintenance and subscriptions increased to 31.8% from 29.9% for the same quarter last year and decreased sequentially from 35.1% in the fourth quarter of last year. The gross margin for appraisal services improved to 30.9% in the quarter from 28.4% in last year`s first quarter, primarily because of inclement weather in the first quarter of `07 which depressed productivity. SG&A expenses were 14.8 million for the first quarter of `08 compared to 13 million for the same period in `07. First quarter 2008 SG&A expenses improved to 24.9% of revenues compared to 25.8% in the same quarter last year. SG&A expenses as a percentage of revenues grew at a slower rate than revenues due to cost management and leverage in the utilization of our administrative and sales staff. SG&A expenses for the first quarter of `08 included $647,000 of share-based compensation expense versus $455,000 in the first quarter of `07. Research and development expense increased 48.5% to $1.8 million in the first quarter, reflecting the development efforts under our new alliance with Microsoft as well as other new product development projects. Research and development expenses increased over the prior year period because staffing for the Microsoft development effort ramped up throughout 2007. R&D expense in the current quarter was offset by $130,000 in reimbursement earned from Microsoft under the terms of our agreement. Year over year backlog again grew faster than revenues, our backlog at March 31st, 2008 was $239 million, compared to $197.8 million at March 31st, 2007, an increase of 20.8% and down sequentially from $250.1 million at December 31st of 2007. Backlog related to our software business which excludes backlog from appraisal services contracts was $214.5 million at March 31st, an increase of 39.1 million or 22.3% from March 31st of last year and a decrease of 8.1 million or 3.6% from December 31st. Appraisal services backlog was 24.5 million at March 31st, 2008 compared to 22.4 million at March 31st, 2007 and 27.6 million at December 31st, 2007. During the first quarter we repurchased approximately 814,000 shares of our common stock on the open market at an average cost of approximately $12.92 per share. Our remaining authorization of shares that may be purchased currently totals 967,000 shares. Our CapEx during the first quarter was $891,000 with no capitalized software development. CapEx for the first quarter of last year was 766,000 and included 25,000 of capitalized software development costs. Although we continue to spend significant amounts on product development, we currently expect that capitalized software development will remain at low levels for the foreseeable future and that virtually all of our development costs in 2008 will be expenses, either as R&D expense or in cost of software services and maintenance revenue. Amortization of post-acquisition software development costs was 1.1 million in the first quarter, down from 1.2 million in last year’s first quarter. Day sales outstanding and accounts receivable at March 31st ‘08 were 90 days, compared to 95 days at December 31st of ‘07 and 84 days at March 31st 2007. December is one of the peaks of our annual maintenance billing cycles and DSOs typically decline sequentially from Q4 to Q1 as we collect those receivables in the first quarter of each year. Our stockholders’ equity at March 31st 2008 was 132.8 million. We continue to have no debt outstanding and ended the first quarter of 2008 with 46.1 million in cash and investments. Included in our investments are approximately $5.8 million of auction rate 16

[John Marr:]

Thanks Brian. The first quarter is traditionally slow in our industry as well as at Tyler and in relation to our 2008 this year’s data consistent with that experience. However, this quarter demonstrated strong improvement in operating results from Q1 of last year with double-digit organic revenue growth, a 90 basis point increase in our gross margin in line with our expectations. SG&A as a percentage of revenue was down from prior year first quarter due to cost management and leverage and utilization of our administrative and sales staff and net income grew 30%. With free cash flow of 16.9 million in the quarter we now have $41 million in free cash flow for the trailing 12 months. CapEx remains low although we continue to devote the same high-level of development resources to product enhancements in development and have increased our planned commitment to R&D for the remainder of 2008. Virtually all of these costs are now being expensed are included in our operating expense structure. Some of the contracts announced during the quarter were in our financial division Spring Branch in Humble, Texas, school districts for a combined value of 3.3 million, St. Louis County, Missouri with a contract value of 4.6 million and our Courts and Justice Division, Galveston County, Texas is a member county of the Conference for Urban Counties with a contract value of $2.7 million. In appraisal services we signed a contract with the state of Tennessee. Total contract value of 15.1 million. For IAS World Property Tax software and related services we signed a contract with Bedford County, Pennsylvania. Total contract value of 1.9 million for IAS World Property Assessment software and reappraisal services. For financial management and education during the quarter we signed 24 different contracts with customers in 16 different states. We continue to have very strong backlog even as we increase our capacity for delivery. Total backlog increased from March of 2007 at a faster rate than revenues. License growth was only 6% and mostly from acquisitions. But license growth is not linear and we do not expect – and we do expect healthy growth in licenses as the year progresses. Overall we expect licenses for the year to grow at a rate equal to or greater than the overall growth rate for the company. And as a result margins will expand as the year goes on. By design we are seeing solid growth and recurring revenue maintenance with growth well in excess of our overall growth rate for the company. As you have seen as a percentage of revenue, maintenance has grown from 40 to 42% year-over-year. This combined with 5% subscription based revenue brings our recurring revenues to 47% of total. And that is only for the contracted portion. Considerably more revenue is derived from these customers for other services and products. As we evaluate our market we are very aware of the broad economic weakness and in particular the pressure on real estate values and the decline of real estate related fees to local communities. While there are some anecdotal signs of these issues effecting decisions in our space there really has been no fundamental change that we can see. Our activity by all measures is relatively normal. However, given the extent of these issues we will continue to monitor very closely. Certainly we have seen these cycles before and we are fortunate to be in a market well insulated from cyclical pressures. I’m confident that we can make progress financially as a business as well as competitively and emerge from the cycle in a better position. Our guidance to 2008 remains largely unchanged with the exception of modest changes to free cash flow in our share account. We expect diluted earnings per share of 49 to 53 cents. For the year estimated pretax expenses of – related to stock options and employee stock purchase plan is expected to be $2.9 million or approximately 6 cents per share after taxes. We estimate an effective tax rate of approximately 33% for 2008. We’ve modestly revised free cash flow for the year to 36 to 42 million with total CapEx approximately of 4.5 to 5.5 million for the year in total depreciation and amortization of approximately 12 million. We have a modest revision in our share account based on our repurchases in the first quarter and now expect fully diluted shares to be 39.5 to 40 million. Now Jason will take questions.

[Operator:]

Thank you. (Operator Instructions) Our first question will come from Fred Buonocore with CJS Securities.

[Fred Buonocore:]

Hi gentlemen. I’m just calling in on behalf of Charlie Strauzer. How are you today?

[John Marr:]

Doing well.

[Fred Buonocore:]

Great. So you’re SG&A declined as a percentage of sales but it had a fairly significant dollar increase. Can you talk about the actual dollar increase there I’d assume largely related to acquisitions. But can you dissect that a little bit for us?

[Brian Miller:]

Sure. Of the SG&A increase a fair amount of it did come from acquisitions. The acquisition impact is at about $1.6 million of SG&A expense. And we also have modestly higher SG&A expense related to stock compensation. That would be the other major impact there.

[Fred Buonocore:]

Got it. And then on gross margins in this seasonally weak quarter, would you say that this – that your performance actually exceeded what you’d expected? And can you kind of just talk a little bit more about the 90 basis point year-over-year improvement that you touched on in your prepared remarks?

[Brian Miller:]

Well the improvement that I think we mentioned in the remarks is pretty much in line with our expectations for the quarter. So generally not a big surprise there. We’ve expected modest improvement in the first quarter and as John mentioned as revenues – particularly license revenues grow through the year, we expect to see margins continue to improve throughout the year.

[Fred Buonocore:]

Excellent, thank you.

[Operator:]

Thank you. We’ll now go to Kirk Materne with Banc of America Securities.

[Kirk Materne:]

Yes, thanks very much. Brian, I guess R&D obviously ramped up year-over-year as you guys brought on guys to work on the Microsoft dynamics project. Do you still have further people to bring on or is that going to grow sort of in line with revenues or is that going to be growing at a slower rate I guess in terms of absolute dollars?

[Brian Miller:]

I think in terms of staffing we’re generally staffed at – in the range of the level we expect to be throughout 2008. There could be modest changes in it but we’re generally ramped up to the point where we’d be throughout the year. The bigger impact on the net R&D expenses as we’ve talked about last quarter, last couple of quarters we are receiving some reimbursement from Microsoft for part of the development expenses to the extent that they arrange with us to use some of the features that we’re developing in their broader commercial product. This quarter that reimbursement, it was recognized as only 130,000. It was a fair amount more than that in the last two quarters and could vary from quarter to quarter. We expect to continue to see reimbursement throughout the year but at this point we do not know exactly what that will be for the balance of the year. So that also caused the net R&D expense to be a little higher this quarter because of the lower reimbursement.

[Kirk Materne:]

Okay, thanks. That’s helpful. And then John, I know you guys have been through a number of cycles like this, down cycles in the market. Could you just talk a little bit about just sort of the deal closure process? Is it different really in the state and local governments than it would be on sort of the commercial side? Meaning if commercial side everybody’s pipeline looks great until you try to close the deal and there’s another set of approvals that comes in and things might go through but they get delayed. Do you see those type of delays in the state and local government? Maybe not now but is that a risk and I guess just how should we view that? Because that always seems to be the bigger issue with software. If it’s not the pipeline does not look good things start getting pushed out on a quarter by quarter basis.

[John Marr:]

Yes, well we’re certainly watching it real closely. I’m only aware of a couple of deals in the last quarter or so that got late in the decision process that did not get finished. And certainly we can look at those and be alarmed if we want them. But the reality is that’s pretty consistent with any tops. So we’re not seeing anything that’s different. And certainly we’re getting asked that question a lot but the pipeline, the demo schedules, the RFT activity as well as decisions are all pretty normal and we are watching very closely to see if some of these deals get dropped as they go through the process. But we have not been seeing that and have not really seen any signs of it. It certainly is not a real robust market so when I mention the past, in my view it’s an opportunity. And we should be able to both perform financially during the period as well as improve our competitive position and some people with some lighter market share may find the market less attractive so we’ll see.

[Kirk Materne:]

Okay. Great. Thanks very much.

[Operator:]

We’ll go now to David Yuschak with SMH Capital.

[David Yuschak:]

Great quarter guys, great start to the year. But one question I’ve got for you guys, your backlog growth has really been as you said earlier, John, been above your revenue gains. And probably from my point of view that backlog growth has been above where I thought your – even your long-term growth could be on revenue relative to the industry. I’m just wondering if you can help us out. Where are you seeing surprises to business being brought in? Because I know you’ve been working on getting that geographic expansion. Is there any surprises that you’re seeing where the penetration is coming maybe sooner or is this in product categories like maybe the schools because some of your recent acquisitions is gaining some traction and some of your additional customers are doing business with elsewhere? Can you guys kind of lay the land as to how that is developing so that you’re turning in at kind of a good bookings rate?

[John Marr:]

Yes, well it’s really across the board, David. In the financial area which is the biggest part of our business, contracts tend to be going into backlog and staying there a little bit longer just based on the terms of the agreements and the accounting around them. The business is in general the same but again I think contracts are – spend a little more time in backlog so it takes a little more time to run them through the financial statement. So that’s contributing something. And then the larger contracts that we’re seeing in tax and appraisal and in courts and justice, they go into backlog as you know and those are generally multi-year agreements that are earned over a long period of time. Obviously we have the Tennessee contract that’s gone in there recently. So it’s really across the board. There’d be large contracts that stay in there for some time. The larger tax and appraisal contracts, the courts and justice contracts and then again contracts in the past that maybe some of the more routine financial deals very quickly move from contracts through the financial statement. Some of them are larger, they’re more complex and based on the accounting requirements as well as the terms of the agreements, they’re spending a little more time in backlog.

[David Yuschak:]

But are you seeing any positives out of your geographic expansion that you may not have –

[John Marr:]

No question. I mean, we’ve made a lot of progress geographically. We’ve said that for a number of years now. I think most of our product sets we now continue to be national products with either a primary or secondary presence in all the markets across the country. So that’s really where we’ve had the most success over the last three or four years really. And again have our sales force spread out throughout the country; have a much larger presence in a number of these different marketplaces. But I think more recently in the last year it would be starting to have more success in the larger contracts. Again, you look at the Tennessee contract, the number of large courts and justice contracts and we do not do a lot of $10 million financial contracts but there certainly are a lot more $2, $3, $4 million contracts in that space as well.

[David Yuschak:]

And then finally on this sales initiative, as you get closer to when Microsoft products begin to roll out, do you see anything changing in the way you maybe accelerate your field sales effort to bring in additional sales to capitalize on that particular initiative as well?

[John Marr:]

Well I think it’ll be maybe a redeployment in our direct effort and maybe growth somewhat about the way we’ve grown that channel historically. I’d expect some increase in capacity there. But really just maybe a change in the way we’re proposing different applications in the direct space. We will have probably kind of a secondary small channel but a number of resources we currently do not have that will exist to support the Microsoft business partners and their channel. So I expect that on a direct basis this will be a good supplement and allow us to achieve higher growth rates on direct basis which is really our current business. And it’ll be entirely new business, what we’ll see throughout the indirect channel or through the Microsoft business partners that sell into other markets. And we’ll need more of a marketing sales support group that has not existed historically. We do have some people that are kind of transitioning over to that now where we’re going to different shows and conferences and meeting these partners in anticipation of that. But it’s really a slice of certain people’s responsibility now and eventually it’ll be full-time responsibility for maybe a handful of people to start with.

[David Yuschak:]

If I understand you, does that mean that there would be more like technical sales people for that channel? Is that kind of what you’re thinking of?

[John Marr:]

It would be a combination of product specialists or technical people. But certainly sales and marketing people that support the process help educate partners around the world really on what the story is and how to position it and support those channels. We have those people internally that certainly provide the different business points and guidance through our sales channel on ASP solutions, on positioning different products. And we’ll want to do that to enhance the indirect channel at Microsoft as well.

[David Yuschak:]

Great, thanks a lot.

[Operator:]

Thank you. (Operator Instructions) We’ll go next to Brian Kinstlinger with Sidoti & Company.

[Brian Kinstlinger:]

Hi guys.

[John Marr:]

Hey Brian.

[Brian Kinstlinger:]

First question of my two is not new information. If I look at the K, your software license in justice was up 26% last year and MUNIS was down eight in education. And then appraisal was down 21%. I’m curious in the first quarter if we’re looking at similar trends; obviously criminal justice like you’ve talked about is your biggest growth riburn [ph]. If those numbers you expect to change drastically this year, especially on the MUNIS side and what are the trends driving it if you will?

[John Marr:]

I do not think we’ll see a drastic change. I think MUNIS for the year last year was pretty strong. And we’re looking for modest growth in the MUNIS licenses for this particular year. Courts and justice we would look for more significant growth. They really had some timing issues in the first quarter and we would look for them to have higher license revenues for the next two quarters.

[Brian Kinstlinger:]

Okay, in follow up on the software license, when you look at your pipeline backlog or whatever you’re looking at for the remainder of the year how do you get a sense of the combination of third party related software that you’re going to deliver versus proprietary? And what’s your sense going forward based on what you see if there is visibility at all to that?

[Brian Miller:]

Well some of that mix can bounce around quite a bit from quarter to quarter. The timing at some of the third party renewals and the mix in a particular contract of how much is third party license versus our proprietary license does bounce around a bit. But it stays generally in the 10 to 15% of the total license revenues are third party and generally 85 to 90% are proprietary licenses. And we expect to be in that range over the course of the full year. But as it bounces around from quarter to quarter based on specific contracts it can have a modest effect on our overall gross margin because the margins on the third party tends to be under 20% and the license on our – or the margin on our proprietary licenses tends to be north of 80%.

[Brian Kinstlinger:]

So it’s choppy is what you’re saying?

[Brian Miller:]

Yes, a little choppy. Yes.

[Brian Kinstlinger:]

My last question if I might, because I do not think I’m the last person in the queue, is you grew 5% in this quarter and 11 last and obviously we know before that was a little tougher and I’m just curious based on talking about no drastic change in the trends from last year how your guidance – what it implies for software revenue. Is it an acceleration from where at 5% or is it you’re thinking the 5% range with services growing much faster?

[Brian Miller:]

It’s definitely acceleration. I think John mentioned in his comments that we expect that for the full year that license growth would be in line with or slightly above our overall revenue growth. And we’ve given that top-line growth including acquisitions as being in the kind of upper teens to 20% range. So clearly we expect an acceleration in the second – or in the last three quarters of the year. Part of that comes from some of the things that John mentioned in terms of some of the timing, some of the contracts that – particularly in courts and justice and tax that have acceleration in the percentage of completion recognition as we move through the year or as we achieve certain milestones that allow us to recognize more revenues on those. And then in the areas where we recognize revenues more on delivery of the software and primarily in financial we would also expect as we typically have in prior years to see sequential increases throughout the year and the license revenues on those.

[Brian Kinstlinger:]

But you do not year over – just so I understand – year over year you’re expecting mid to high teens which is based on your overall revenue. But that’s what you’re expecting on the software license line specifically?

[John Marr:]

That’s right.

[Brian Kinstlinger:]

Wow, okay. Great. Thanks.

[Operator:]

And at this time there appears to be no more questions. Mr. Marr I’ll turn the call back over to you for closing remarks.

[John Marr:]

Okay, well thank you Jason. We appreciate all of you joining us on the call today. If there are any further questions feel free to contact Brian or myself. Thanks again. Have a good day.

[Operator:]

This does conclude today’s teleconference; you may now disconnect and have a nice day.