泰勒科技 (TYL) 2008 Q3 法說會逐字稿

Hello and welcome to today's Tyler Technologies third quarter 2008 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.

Welcome to our third quarter 2008 earnings call. With me on the call today 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, and Brian will review the details of our operating results. 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 would refer you to our Form 10-K and other SEC filings for more information on those risks. John?

Thanks, Brian. Well, the third quarter 2008 has proven to be very strong across the board at Tyler. We are pleased to have posted our 30th consecutive profitable quarter. These results are a testament that our strategies and business model are sound and our product are competitive, and that Tyler's nearly 2,000 employees are executing at an exceptional level. Our third quarter and year to date results exceeded our expectations by a substantial margin with nearly 25% revenue growth in the quarter and 22% year to date. As importantly, the revenue mix has been favorable, with higher margin licenses, recurring maintenance and subscription services leading the way. All of this delivered new quarterly highs in several key measures, including total revenues, operating income, EBITDA and free cash flow, excluding our real estate acquisitions. In fact, our free cash flow continues to be exceptional. In the quarter we saw an 81% increase in free cash flow excluding the real estate acquisitions. Later in the call we will review our latest guidance, but through September 30, our actual trailing 12-month results are revenues of $256 million, earnings per share of $0.60 before the legal settlement, and $0.40 after the settlement, and free cash flow of $50.3 million before real-estate acquisitions. Now I would like for Brian to provide more detail on the results of the quarter.

Thanks, John. This morning Tyler Technologies reported its rules for third quarter ended September 30th, 2008. This was financially our best quarter ever by most measures, with very strong earnings and even stronger cash flow. You all have access to the press release and our Form 10-Q has now been filed, so I am going to limit my comments and focus on providing an analysis of the key factors contributing to our results this quarter, then move on to John's comments on the current quarter and our outlook for the rest of the year as well as Q and A. Revenues for the third quarter were $68.6 million, up 24.9% from the third quarter of 2007. Our organic growth for the quarter was approximately 15% and about 10 percentage points of our growth was the result of acquisitions we've made over the past 12 months. We posted double-digit revenue growth across all of our software-related revenue lines. Software licenses were up 40% and topped $11 million for the second straight quarter.

Licenses from our Odyssey Courts and Justice Solution was the biggest contributor to the increase and included some license revenues that had previously been deferred pending achievement of certain milestones. Licenses from other product such as financial management and education systems and appraisal and tax systems also increased year-over-year. Subscription revenues grew 38% over last year's third quarter, reflecting revenues from new customers as well as existing customers that have converted to our ASP model. During the quarter, we signed two new ASP customers and converted existing customers. Growth in the base of customers subscribing to our disaster recovery services also contributed to the increase. Maintenance revenue growth was 28% with acquisitions accounting for approximately 11% of the growth and the other 17% organic. Together, recurring revenues from subscriptions and maintenance comprised over 45% of our total revenues for the third quarter, in addition to substantial amount of service revenues that are attributable to existing customers. Software services revenues grew 17% with increases across each of our major product categories. Finally, appraisal services revenue increased 7% in the third quarter after showing year over year declines in the previous three-quarters, primarily due to the ramp-up of the revaluation product in New Orleans.

For the third quarter of 2008 our blended gross margin increased 420 basis points to 43.6% compared to 39.4% in last year's third quarter. The strong improvement is attributable to a more variable revenue mix, and particularly the high level of license revenues and operating leverage including improved staff utilization that contributed to higher margins across each revenue category. Sequentially, gross margins increased 50 basis points from 43.1% in the second quarter 2008. SG&A expenses were 23.3% of revenues and 23.1% for the same period in 2007. The incremental SG&A expense related to acquisitions was primarily responsible for the slight increase in SG&A as a percentage of revenue. Net research and development expense was $1.4 million for the third quarter 2008 compared to $639,000 for the same period last year. The increase is primarily due to staffing increases associated with our joint development effort with Microsoft on the Dynamics AX ERP product for the public sector.

Research and development expense for the third quarter of 2008 includes $857,000 of cost reimbursement recognized under the amended research and development agreement with Microsoft. R&D in the third quarter of 2007 was offset by reimbursement from Microsoft of $883,000. We have recently revised our agreement with Microsoft to define the scope of reimbursable development through the balance of the project, and we now expect to offset R&D expense by approximately $850,000 each quarter through the end of 2010. Operating income was $11.9 million, a nearly 51% increase from the third quarter 2007. As we discussed last quarter, we settled outstanding litigation related to stock purchase warrants and recorded a noncash charge of $9 million in the second quarter of this year. This charge was not tax deductible and had the effect of significantly increasing our effective tax rate for the second quarter and each subsequent quarter in 2008 as we must allocate the tax impact prospectively for the 2008 calendar year. In order to more clearly present our operating results on a comparable basis, in addition to GAAP income numbers, we have also provided non-GAAP results that exclude the effect of the noncash warrant settlement.

A reconciliation of earnings before the impact of the legal settlement to GAAP income is included in our earnings press release. For the third quarter of 2008, the impact of the legal settlement resulted in an effective tax rate of 48.4%, and additional income tax of $1.5 million. Non-GAAP net income for the quarter, excluding the income tax effects of the legal settlement was $7.8 million or $0.20 per diluted share, an increase of 52% compared to net income of $5.2 million or $0.12 per diluted share in the third quarter of 2007. Including the impact of the legal settlement, GAAP net income for the quarter was $6.4 million, or $0.16 per diluted share. As we have discussed before, our business model has very attractive cash flow characteristics that consistently produce annual cash flow well in excess of GAAP earnings. That certainly was the case tin third quarter when cash from operations was $27.5 million, an increase of 74.3% from $15.7 million in the same period 2007. The third quarter is historically our highest cash flow quarter of the year because we invoice a significant portion of our annual maintenance and support in June, and collect much of that cash in the third quarter. We also have collected cash on contracts containing milestones, and reduced our DSOs, so total receivables grew at a much lower rate than deferred revenues.

Before capital expenditures for real estate acquisitions free cash flow for the quarter was $26.6 million, compared to $14.7 million in 2007. Our total capital expenditures during the third quarter were real estate for the company's third quarter was 13.6 million for the quarter. CapEx for the third quarter of last year was $1 million. We also expect to complete the purchase of our office facility in Falmouth, Maine for approximately $10 million in cash during the fourth quarter of this year. For the first nine months of this year, cash flow from operations was $45.4 million, compared to $24.5 million for the same period in 2007. Year to date, free cash flow for 2008, excluding the real estate acquisitions, is $41.9 million versus $21.8 million for the first thine months of 2007. We did not capitalize any software development costs this quarter, and amortization of post acquisition software development cost was $975,000 in the third quarter, down from $1.1 million in last year's third quarter.

Our backlog at September 30, 2008, was $235.6 million, up approximately 4% compared to $225.8 million at September 30th, 2007, and down slightly from $238 million at June 30th of 2008. Backlog related to our software business which excludes backlog from appraisal services contracts was $209.8 million at September 30, an increase of $11.7 million or 6% from September of last year. Appraisal services backlog was $25.7 million at September 30th, 2008, compared to $27.6 million at September 30th 2007, and $22.9 million at June 30, 2008. As we have built up our implementation capacity over the past few quarters, we have been successful in bringing down the level of backlog for certain products including our Odyssey Court System to more closely align with clients' desired implementation time tables. As we've discussed in the past, we've had two primary uses of our free cash flow, in addition to substantial ongoing investments in our products that are expensed to either (inaudible).

One of those uses of cash is our stock repurchase program. We've been a very consistent buyer of our own stock for several years. We have a long-term jut look when considering the valuation of our stock, and with the recent in the market, we believe our stock is a particularly compelling value. During the third quarter, we repurchased 1.097 million shares of common stock at a total cost of $16.9 million, and for the first nine months of this year, we've purchased a total of 2.194 million at a cost of $31.3 million. Subsequent to the end of the third quarter we have purchased an additional 1.5 million shares for an aggregate purchase price of $20.6 million. We now have about 36.3 million basic shares outstanding. Last week, our Board of Directors increased by 2 million shares our repurchase authorization, so we may currently repurchase up to approximately 2.068 million shares of our common stock. It's remarkable to look at the accretive impact of our stock repurchases, since we began buying our stock back 6 years ago. Since the beginning of 2002 we have repurchased a total of 17.4 million shares of Tyler stock at an average cost of $7.86 per share.

The second use of our cash was then for acquisitions. We completed one acquisition during the third quarter, acquiring School Information Systems, Inc. for $9.9 million in cash and 70,492 shares of common stock. SIS is based in St. Louis and provides financial and student information management systems for public school districts, with 275 school districts as customers, primarily located in Missouri and Illinois. We expect to expand the reach of the product suite into additional states as part of the Tyler organization.

On the balance sheet, we ended the third quarter of 2008 with $34.3 million in cash and investments and no debt. Days sales outstanding and accounts receivable at December 30, 2008, improved to 87 days compared to 93 days at September 30th, 2007. This represents the lowest DSO level in six quarters. We also announced today that we have established a new revolving bank credit facility that provides for total borrowings of up to $25 million, in addition to a $6 million facility for cash secured letters of credit. Borrowings under this one-year facility will bear interest at either LIBOR plus 1% or prime rate minus 1.5%. We established the line of credit to provide additional working capital availability to ensure that we have the flexibility to take advantage of opportunities with respect to potential M&A activity as well as stock repurchases and capital expenditures. We also continue to consider leveraging our real-estate assets once we complete those acquisitions.

Now I would like to turn the call back over to John for his comments on the quarter.

Thank you, Brian. As you now know, our results were strong and it is important to appreciate that this represents a broad based success. There really is no unusual or single event that is responsible but rather consistent execution across the entire business. Our balance sheet is evidence of strong cash flow characteristics of our business. At September 30, we had $34 million in cash after investing over $68 million in cash year to date for acquisitions, stock repurchases and real estate. So the company has seen considerable growth in revenues with leverage and even better growth in earnings and free cash flow before the real estate, and as importantly, we believe we are making investments that will, in turn, turn those earnings and free cash flow into shareholder value downstream. So we're enjoying a very good 2008 but I appreciate in the current environment that most are interested an looking forward. I wish I could tell you exactly what the next year and beyond will look like. I can't. But I will offer some observations from our perspective.

First, our company is built on strong fundamentals. Nearly half of our revenues are recurring with less than 2% customer attrition. In these times, customer loyalty will only strengthen. We have a strong backlog, $235 million at September 30, and there are other considerable revenues that we execute every year that are relatively certain but not represented in either of these numbers. In our view, with all this considered, there's a core level of reliable business that we can count even in these extraordinary times. Tyler also enjoys a strong balance sheet and excellent free cash flow, resulting in very little exposure to the volatile credit mark. It is likely that all marks, including local we are experiencing. To what extent and at what time is something that is hard to predict, but as with our own business internal fundamentals, the fundamentals of the local government software market will be favorable over the long term.

For years, now, local government has been asked to do more with less, and the current environment will only hasten this trend. Our products and services are not discretionary choices of local government but the tools they use to be more efficient and actually deliver more with less. There is a tremendous inventory of old systems out there nearing the point of unreliability. They need to be replaced. Is there some discretion as to whether that occurs next year, or further down the road? Yes. Is there any question that it needs to occur sometime in the reasonable future? No.

So no, I can't tell you exactly what things will look like a year from now, but given our large customer base, our recurring revenue, strong backlog and excellent competitive positions, I believe we will continue to deliver decent results. Think about it, our free cash flow and our EBITDA are greater than our total license revenue. I'm confident this will allow us to manage through these times. But more importantly, the fundamentals of our market are strong. Local government will make some adjustments, and it could, could, create some short-term pressure. But this will be a bigger marketplace three and five years from now. These governments as a group will be bigger, not smaller. Their need for the solutions, our solutions will be strong, and we will be in an increasingly strong position to serve those needs. This morning, we also announced that we recently put a new bank revolving credit in place. This affords us the ability to pursue attractive acquisition opportunities, continue our repurchase program, as well as invest aggressively in our product. Our ability to obtain this line in these times with attractive terms is indicative of our strong financial position.

Based on our strong performance year to date and our outlook for the remainder of the year we have revised upward our guidance for the full year 2008. We currently expect 2008 revenues to be in the range of 262 to $265 million. We forecast 2008 diluted earnings per share to be approximately $0.57 to $0.60. Before the noncash settlement pertaining to the warrants, earnings of 34 to 37% including the settlement. Fully diluted shares for the year are expected to be approximately 39 to $39.5 million. For the year, estimated pretax expense related to stock options and the employee stock purchase plan is expected to be $3.5 million, or approximately $0.07 per diluted share after taxes. We estimated an effective tax rate for 2008 of approximately 38% before the impact of the legal settlement and 49.9% including the settlement. We expect free cash flow for the year to be within a range of 22 to $26 million with total CapEx of approximately 30 to $31 million for the year, and total depreciation and amortization of approximately $12 million. Excluding real estate CapEx, we expect free cash flow to be between 48 and $53 million.

Now Jason, we'll take questions.

We'll now begin the question-and-answer session. (OPERATOR INSTRUCTIONS). We'll pause momentarily to assemble our roster. We'll go first to Charlie Strauzer with CJS Securities.

My two questions are pretty straightforward. Brian, if you are looking at Q4 how should we think about the segments and the expected growth by segment there, and any real big changes on the gross margin line by segment?

I think Q4 by segment would look very much like Q3. Continue to -- which would mean financial systems continuing to be a strong contributor and the courts of justice area having come on-line more meaningfully in the third quarter, continuing generally at that level.

Got it. Then just overall, if you look at the gross margins by reporting segment, should we see much difference there, too?

Not particularly. The biggest change obviously is that the gross margin on the license line varies pretty significantly depending on the revenues, because the cost of licenses are relatively fixed, but otherwise, there's nothing that would point to anything other than the kinds of changes the margins you get with volume changes.

Got it. And then looking out, touching on the Microsoft agreement, Brian, if you can highlight what aha changed since the last amendment to the agreement, how is this new amendment different from the last one?

Well, the last one had really the spirit of an arrangement in place, which was that development we were doing for the public sector system that had value to their commercial or horizontal system, that they would have an ability to contract with us to get IP rights to that and pay for it now and move it over there. So that's still the basis of our arrangement. But really what it didn't address was, looking over any reasonable period of time trying to quantify that and come up with an arrangement that was a little more consistent and had better visibility. So since then, we have looked at really the balance of the development project through the first release to manufacturing and quantified that and quantified how much of that has value to them and they choose to include in their commercial system and come up with a much more predictable model. So that we will have relatively flat reimbursement through general release late -- really, through the end of 2010. So that was the major change was trying to look out, quantify it and put an arrangement in place where they knew what their costs were to this quarter to quarter and we knew what we could expect from a reimbursement standpoint. So it's only if we were to see a very material change in the product that that reimbursement would change, and we don't expect that to happen.

Got it. John, when you talk to Microsoft and the people there, given all the turmoil of the last several weeks and months, what are they saying to you in terms of receptivity for the early quiet tests that they've done and the rollout dates and all those things kind of related to that? What are they kind of saying to you?

I'd say, as you might expect, that they continue to execute -- I think both companies, obviously at very different levels, but both companies are in a position to continue to support these kind of longer term development efforts regardless of the current environment, and again, at very different levels, but both companies in the last week now have reported strong results and an outlook that is certainly reasonable enough to continue. So we don't expect this project to be affected by the current market. As I indicated earlier, I don't know how many projects that might have occurred next year might get pushed out a year or two, but if they were on the table for next year, they're going to occur sometime in the next few years. So really, if you think of it that way, there could have been some business that would have occurred in the next year or two as we finish up this project that will be on the table when the product actually hits general release. So I met with them last week. We have similar views as to remaining committed to the project, getting it done. It's on schedule. It's generally on budget, and we think there will be a good reception in the marketplace down the road.

Excellent. John and Brian, thank you very much.

And we'll take our next question from Kirk Materne with Banc of America Securities.

Thanks very much. Congratulations on the quarter. Just maybe taking a look at your guidance for the fourth quarter, Brian, when you back into it, seems that the seasonality from 3Q to 4Q this year versus last year is a little bit more -- a little flatter sequentially. Can you go into that, whether or not there's some deals that came in? I realize you don't give quarter by quarter guidance, maybe my split was just wrong to begin with but can you talk about the trends we should think about, maybe from a seasonality perspective, from 3Q to 4Q and any suggestions would you maybe have for us going forward on that front?

Sure. In the past, the fourth quarter has typically been a fair amount stronger than any other quarter during the year. And I think we're seeing that starting to smooth out a little bit, and they're less pronounced increases just from seasonality as we've grown, our business has spread across more geographies, spread across more customers, so we see a little bit less of that hockey stick effect on the fourth quarter. And this quarter there was some things that were timing, so clearly we've increased our guidance for the second half of the year. As you noted we don't give quarterly guidance. We leave that up to the analysts and you guys to put in your models, and some of that is actually not predictable from quarter to quarter in terms of when deals sign and when licenses are recognized. But there was a little bit of timing in terms of things that we might have expected internally to have happened in the fourth quarter that happened in the third quarter that made this quarter a little bit stronger, particularly on the license side, but I think over time we are seeing a little bit more of the smoothing of quarter to quarter. Clearly a lot of our revenues maintenance and subscriptions, recurring revenue type things are driven just occur based on time passing rather than deals closing in the quarter.

Great. My second question, I guess, John, none of us have a great crystal ball into next year, especially from a revenue standpoint, but there are some things you guys can control in terms of you do after good view into maintenance revenue, subscription revenue and sort of your OpEx. I guess when you have had a nice lift in margins this year, I guess, could you just talk about, maybe qualitatively? Because I know you don't want to get into guidance but qualitatively about your ability to sort of manage your margins as we head into next year and what our thoughts should be in terms of further margin expansion from these levels as we go into '09, because I recognize that revenue predictability is going to be very difficult. Aim just trying to get a sense on how closely you guys think you can manage sort of the cost structure if revenue growth were to sort of trail down a little due to the macro factors.

Certainly, we're giving an awful lot of thought to that, and we're in the 2009 planning process, and talking an awful lot with the divisional management teams regarding that. If you really look at what we see and touch in our own business, as you see from the quarter and the guidance of the balance of the year and that certainly trickles into the beginning of next year, what we see directly is healthy. And so we don't want to take off the table objectives we've had traditionally for growth and investments in product and these sorts of things if we don't see those things. On the other hand, obviously, you have to be aware of what's going on externally, and you have to acknowledge that it could put some pressure on our space. I think we're better insulated than most commercial businesses, and even better insulated than most government segments, but certainly we would appreciate that there could be some guidance. So we're really working hard to have a more dynamic plan that does try to achieve what's available to us in the marketplace, but rather than lack at things as an annual plan with some measures along the way, have an awful lot more in the way of consistently being perceptive as to what's really happening in this space and have the variable expense increases only go into effect and occur, the hiring of the people and so forth when we can touch and feel those revenues.

So it will be a much more dynamic plan, and it will be more aggressively managed. You are getting rate at what is our job, and as we see it going forward, I don't -- I certainly believe our company will have some growth next year. If you just look at the trajectory of maintenance revenues and subscription revenues and backlog of work, there's growth built in our model as we leave one year and go into the next. But, if it's lower than it would have been, then we need to work hard to protect the margins we've achieved, which might be the best you can do. And again, if there is that final increment that we think we would realize in ordinary times, then that's an opportunity, obviously, for the margins to expand. So, anyway, the net I would say, I think we will certainly see some growth even in a difficult market, and I think we'll have an opportunity to have margins generally in the range that we're currently experiencing, and yet we will have a plan that we'll look for opportunities for better growth and broadening those margins as well.

Thanks very much. One last question, if I may. John, can you just remind me on sort of the cycle of -- I know the Federal Government is on sort of a September year end. Can you go into a little how the state and local governments on -- just sort of the cadence about when they will start putting out RFPs? It might differ by region but can you give us some color on that?

Yeah. There are really two things to consider there. The nice thing is as Tyler has grown geographically around the country, and that's part of the answer to your earlier question where we had seen more of a hockey stick before and we see more of a leveling now of our revenues and earnings, part of it is a result of that. So there really are three different fiscal cycles around the country. I think the most predominant is a June 30 fiscal year end. So I think that is the most commonly used, mostly driven because of the educational side. Second to that would be the calendar year, and third to that would be the fiscal year, September 30. I'm not aware of states that have the first quarter as their year end. So it is spread out some bad and balanced a little bit. The other thing that has always gone on and is interesting is that different chance and different projects use that different ways. There seem to be a lot of governments that right now are preparing a budget and will put money in that budget, put $1 million or $2 million or whatever they think is appropriate to replace a system, and then once that budget is approved, they will begin the process of going out and seeing what they really want and making a selection that will occur months later down the road. And then there are others that go out and go through the process, and decide exactly what it is they want and how much it's going to cost, then they go and get the approval. So all of those things combined I think, again, are contributing to somewhat of a leveling of business as it occurs.

Great. Thanks very much for answering my questions.

And we'll go next to Brian Kinstlinger with Sidoti and Company.

Good morning. I appreciate the discussion of uncertainty for next year. Are you beginning to see any push-back yet from customers and how is that impacting pricing at all in the mark place?

I don't know about push -- I haven't seen a lot of push back with customers, installed customers. I think, again, their understanding that they need to support the investments they have and rely on those systems and the fact that they're not discretionary, that that will remain pretty solid nor the customer base. Again, on the new business side, they will be projects that might happen this coming year, and they will be incremental applications that might have been sold into our base that may not occur at the same rate. So we expect to see some of that. We've seen some anecdotal evidence of certain projects being delayed or going off. We've seen maybe some customers looking to purchase something from us, installed customers that, a lot of it is cultural, that just didn't feel like fighting for that budget share at the current moment. Again, I think the fundamentals of our business and the marketplace are such that we'll still make some progress during these times. Maybe not at the same level.

Pricing can really be a double-edged sword and one side of that is to our favor. We've got very compelling offerings. We're very cost effective on the higher mid range and the lower tier 1 type space, and think some of the market that was less price sensitive and going with the tier 1 vendors in some cases at much higher costs, we have again seen some anecdotal evidence and heard some comments from some of that marketplace that the cost itself is going to be a bigger mix of the decision, and that will help us in that particular marketplace.

Great. And to that point, your software license on pace, similar quarter, 43 million is there anything there recurring? Because I know the maintenance and services vary. When you look to next year how much of that is either in your backlog that you have to hit certain points in the program and how much has to be new business that you book through the year, whatever that number is, how much comes from your backlog versus new business?

We don't break out --

We don't have anything recurring.

We don't have the breakout of the licenses separately, but there is a portion of the licenses that will be coming out of backlog, particularly on the courts deals and our property tax and appraisal systems, some of our larger financial systems that either have milestone-based revenue recognition on licenses or more often percentage of completion accounting that those are recognized as services are provided.

But most of them are new bookings.

I don't know.

Couldn't tell from the income?

We can find out for you.

That's okay. We'll get that off-line.

Certainly a meaningful part comes out of backlog. Whether it's more than half, I'd have to look.

I guess in relation to the question that the previous analyst asked, I guess I was confused, and this is pure hypothetical. Suppose in the second quarter you did start to feel it. Does that mean you'd be prepared to implement something to cut costs? You're not sure? I mean, I'm just trying to understand how quickly you can manage costs while you're increasing R&D somewhat and SG&A to something actually happening. Could that happen in three months? Six months? I remember it was very quick back in the days of tax and appraisal, so I'm just curious in today's market is that similar or not.

Tax and appraisal is pretty different.

Right.

We had very high project oriented revenue there, and as those projects ran off they weren't replaced. A lot of resources that weren't really funded. As I've said earlier, and it's an environment we want to be very careful about predictions but the trajectory of our maintenance revenues and subscription revenues and the size of the customer base that grows significantly year to year, all of that suggests that revenues would certainly be higher next year than they are this year. So I don't see dramatic -- I don't see, based on what we're currently seeing, a need for any kind of a reorganization or down sizing of resources what. I see is an environment where we certainly can't take for granted the growth that we have, and we need to watch very closely, and if that growth doesn't materialize, and if some of that new license revenue doesn't materialize, that we manage our resources more aggressively, and we hold the line more than a reduction, because again, I don't see a situation where revenues would be lower next year than they are this year, so it's really about incremental costs and incremental revenues. That could mean redeploying certain resources from certain areas of our business to other areas of our business but even if we experienced, and I'm not suggesting we will, a reduction in new license revenues, those -- that reduction would be offset by increases in maintenance and subscriptions and other types of services, and we should be able to manage within that without any kind of a significant restructuring.

Last question I have is related to Microsoft. We have the new agreement here, and I'm curious sort of how many guys you have on that development program, where that might go next year, and given that they're going to be reimbursed $800,000, does that suggest we won't be up next year in R&D expense? That's the one thing it seems that you do have visibility to. Maybe you can give us a sense of. That.

We'll be up. We're in the area of 70 FTEs right now and that could grow as much as 50% next year.

Some portion of that, reimbursement will be maybe double next year what it was this year, so some reasonable amount of that growth will be offset by higher reimbursement, but our costs on the Microsoft project, the way it's currently contemplated, will go up a little bit next year. $1.5 million, $2 million, something that in range.

Great. I'll get back in the queue.

Brian, I'll pint out on the backlog, our backlog at September 30th about 60% of it is licenses and software services with the balance being subscriptions maintenance and appraisal. So about 60% of that backlog would be license and services, and I don't have the split between the two, but it would be reasonable to assume that it wouldn't be too far off from our overall revenue split, the relationship between the licenses and services.

Did you he revise the third quarter of last year? Because in the report you said $198.2 million of software. That would suggest 5% increase, but you said 11% in your prepared remarks.

Third quarter last year?

The release says 198.2 in software-related backlog. Seems that maybe that should be a lower number last year based on what you were mentioning.

No, that was the number. I don't have a revision to that. I'll to have go back and look. That's the number that we're showing for last year, September. 226 of total backlog and 198 of nonappraisal.

Right. That's what I have. Okay. Thank you.

We'll take our next question from David Yuschak with SMH Capital.

Great quarter. Let me ask you about your real-estate spending this year. When you take a look at your PP&E at the end of the year, versus what it is now, obviously it's a pretty significant commitment you're making in the way of real estate. Could you give us some sense as to what you kind of envision with this kind of investment? Because it would potentially demonstrate a lot of capacity to do a lot of things as you put that real estate into productive use.

You mean actual use of the facility, rather than a financial question?

That's right. That's a pretty significant investment as far as what kind of needs you have in a way of facilities and the rest.

That's right. And we have talk about that on a previous call. All the real estate being acquired or built is in two different markets. The Lubbock, Texas markets where the IMCO division has grown, and the main market, Falmouth and Yarmouth where we have our Munith area, and we're committed to all our different facilities. As I said, we don't see reorganizations or downsizings of any of those, but as we manage the business going forward there are certain markets that are more productive for us than others and we will try to direct the growth and have directed the growth in those areas. These markets are kind of secondary markets. We have a presence in the Dallas-Plano area. We have a presence in Seattle which has been useful on the Microsoft project. We have offices on 128 outside of Boston and in research triangle in the Carolinas. And we have some good talented contributors in those areas.

But as we grow, a lot of resources these secondary markets are very cost effective for us. We have good loyalty and longevity among the employees so they're markets where we've been able to attract and retain long-term relationships with employees, we're an employer of choice in those areas. We don't experience people going across the street for marginally different pay or that sort of thing so we've made a conscious decision that those are good markets for us to grow in and those divisions have been very successful attracting and keeping those people. Probably 100% of one of the buildings in Maine is and has been occupied by Tyler for years so it's really just buying a building we're already in and have a significant investment. That's where our ASP facility is and a lot of infrastructure is in place. The other building is currently leased out to the seller and as it becomes available the projection of our growth here would be such that we would be filling that very consistently as it is released.

And if you don't do something like that you have got a lot of employees scattered over a lot of different buildings on a temporary basis, and it's just not as productive of an environment. And then the Lubbock environment, they're in three different facilities right now, they're spread out, they're stuffed into those facilities, and we need to bring them together under one roof so to speak, and to give them a more productive environment. The reality is there simply doesn't exist a space that size and that quality in the Lubbock marketplace, and we made a decision to build it.

At your user conference you indicated several states now looking at potential proposals, RFPs to implement a court and justice system. Could you give us a sense as to some time lines? I think there was maybe upwards of eight states reviewing prospects for new systems. Could you give us an idea? Because again this speaks to optimism on the part of City and County government to move ahead and spend wring there is a knee. Could you give us review of where those states may be on a time line as to when they want to make a decision or at least as where they may be thinking about moving ahead?

Quick answer is no. For years when Brian and I started hosting these calls we kind of got specific opportunities out there, and there was a lot of enthusiasm around Odyssey. It's very difficult to know exactly when a state or a County is going to make a decision. Obviously we don't want to start getting those specifics out there and having to respond to them when we don't control them but we're tracking a number of states that we think have decisions in their future. I would think some of them certainly would be in the coming year and certainly some of them would be further out. There are other large counties that will be making those decisions as well. So we see a good volume of business as we go forward. As Brian indicated, we worked a little more backlog off because we've built up the delivery resources now on the Odyssey side of the business, and obviously looking forward to replace that business with other deals. We see those deals, but not trying to avoid your question, David, but I think it's hard to predict exactly when this will occur. But given the volume I certainly expect some meaningful decisions.

Certainly speaks to your customer base out there at this point, from the pipeline, does not look like there's a lot of extraordinary caution if, in fact, there is a need to have that facility brought up to date, so to speak.

that's right.

okay. And then one last thing. On the ASPs, you indicated, I think, Brian, that you converted eight, was it?

Yes.

how many do you have now in total?

Total customers is --

109.

So that's getting to be a very promising part of the long-term business model as well then.

It's relatively small, but it's fast growing, both in terms of number of customers and revenues, all bet on a smaller base. I think what you saw in the quarter, more traction in the installed base and the new business market is G. we've certainly recognized that and we'll be certainly making the customer base aware of that and try to drive more of that. There isn't the opportunity cost of licenses that you have with new clients. So we're pleased with the traction in the installed base and we'll be pursuing that.

That's all I got for now. Thanks.

Thank you. We'll take our next question from [Dale Warmington] with Delwar Capital.

Quick question. Your tax rate, could you explain why so high?

The tax rate is abnormally high this year because of the effect of the settlement we had last quarter with Bank of America regarding the dispute over the warrants. So the way that was treated was that we issued warrants that had to run through the P&L, and that's a nondeductible expense treated as an equity transaction for income taxes. So it's a nondeductible, noncash expense that boosts our effective booked tax rate. So we'd be at about 38% excluding that one item.

Okay. And one last question. In terms of your revenue break there is down by geography, what percentage comes from Canada and the UK?

Be very small. Less than 5% of our revenues that would be from outside of the US, and most of that would be Canada at this point.

Okay. Thanks.

And we'll take our next question from Robert Moses with RGM capital.

good afternoon, guys. Just had had two quick questions. One is really on kind of just framing the long-term revenue opportunity. I think, John, you've said in the past that kind of a low to mid double-digit growth is kind of where you had hoped the company would be, and I guess through nine months you're definitely there this year. That would be kind of a market growth of kind of, I don't know, 6 or 7%. Is that kind of generally the long-term view?

Yes.

and so if we go into next year, you certainly will do better than the market. The question is, is the market flat? Is it up? Kind of where it is. Doesn't sound like you're seeing a lot of indication that it's anything other than normal, but you're just kind of throwing up a caution flag given everything that's been on, at least the last couple months.

it's more than a caution flag. We understand this market. A lot of us have been in it a long time. I have no question that somewhere tonight there's a budget meeting, and somebody is going challenge someone on the idea of buying a new system and whether it has to happen this coming year or could be held off for another period of time. So I expect that whatever the market would have been, it will be something a little less than that now. I don't know if that will be enough that we can get the kind of growth that we've said we expect to have over the long run. I think we'll be able to certainly get our market share out of that.

But as I said, I think if you look -- even if that one system is deferred a year, if you look over next three, four, five years, I think you're going to see the same volume of business you otherwise would have seen regardless of the current environment. But exactly how it affects the timing of some of these systems is a hard thing to know. Again, the trajectory of our maintenance growth, our subscription growth, our backlog, a lot of these things would suggest that we would have higher revenues next year than we have this year, and we should be able to manage to that but whether they're a little less growth than we'd see in most years will remain to be seen.

Makes sense. Second is just on the use of the balance sheet. The excess cash and the new credit facility. Certainly you have some things in the fourth quarter, I guess you've already bought back north of $20 million of stock and you've got the $10 million earmarked for Falmouth, so as we think about going forward with the cash you're generating in the fourth quarter and beyond, just help me with how you think about kind of buyback versus acquisitions, because I know your stock has come down a bit, and, t's pretty intriguing yield, but how are you looking at other acquisitions? Is are you seeing pricing coming down in those as well?

Yeah, we had thought we have we've seen some dailies that our discipline was such that we weren't interesting to them initially, and they'll come back around because there isn't a market where they can just go get their price. So we have seen some indications of that. But as you can see from the results we actually haven't closed an awful lot of acquisitions recently. So we have seen indications. Aid think there will be some attractive assets out there that will be more reason all in terms of their valuation expectation, and we hope to participate in that. But we haven't seen high volume real recently, as you know. There is no question that with our stock at the price it's at, if it were to remain in that range, we'd feel good about our company and this asset, and we will compare the valuation of day ler to how we value other companies, and when you buy your own company, there aren't integration issues, there isn't a level of uncertainty, so we feel very good about day ler's long-term outlook and obviously if it's more favorable than an acquisition that will weigh into the decision process.

Generally, John, I know there's a lot of different metrics go into it, but kind of free cash flow, as you look at your own business, and I guess it's like $1.25 $1.30 per share on a cash flow basis, free cash flow is that the major metric you would look at for your own business in terms of buying back your own stock?

It is the way I think a lot of you guys are looking at us and essential the way we look at it. It can be a little lumpy. I did say our trailing 12 months free cash flow is $50 million. At the end of the year it will be something like $50 million as well. And obviously that's a pretty compelling valuation matrix, assuming it's sustainable. We had a very strong third quarter for free cash flow. It isn't accounting. It's free cash flow. So taming can work into it a little bit more. Whether that's the new level we just build on or whether it got a little bit ahead of itself we'll have to see. But we will look at a more conservative outlook than what this quarter brought to us in terms of the year and the trailing 12 months as we make those decisions.

Fair enough. Thanks.

(OPERATOR INSTRUCTIONS). We'll take a follow-up now from Brian Kinstlinger with Sidoti.

You guys normally discuss the RFP situation. Are we seeing as many as we were in quarters past? Are we seeing a little less? Give me some sense where that's trending.

Yeah, we are seeing a little bit less. We were seeing a little bit less even before the last month or two, and so we're tracking that very closely. The volume of RFPs is actually off a little bit, and again, was off a little bit before the current mark got to the point that they're at, so I'm not sure that is at all reflective of the most recent market changes here in the last month or so. The average sales price, the average size of those is up a little bit. So that offsets that a little bit. And our competitive position, or our mark share has improved reasonably meaningfully. So as a result, you see that our license revenues are up, and we continue to execute well within that. But in terms of the absolute number of RFPs, they are off a little bit.

And in terms of appraisal services revenue, at what point is there one of these programs that roll? When is the next big program that rolls off? Anything that's meaningful to that $20 million of revenue?

Well, there actually are a number of states going into cycles, so we do see new business out there in the marketplace. We're clearly the lead on the larger opportunities out there. There are a few companies in that marketplace these days, and ability to bond those and pursue those, so there's actually a number of states that are coming into their cycle, and there should be -- we believe there's a reasonable amount of business to come on-line, so we really think the level we're at is pretty stable bottom for appraisal services. We do have a large engagement in New Orleans, which is going well and contributing to their success, and what is that, Brian, 18 months left?

It was about a two-year project, and it's really kind of kicked in, in the last six month.

We don't have a lot running off. In those markets the cycles are actually going to turn in our favor. We're at kind of the lower end o our range, as you know. So we don't see a lot of exposure to the downside. Last question is related to real estate. I think that you purchased. First of all, how long is Nike committed to leasing that business, and then Brian -- sorry, not the business, the space. And then -- if I have that right. And then Brian could you go other the amortization roughly quarterly for that building versus the lease income you'll be getting?

I can answer the lease while Brian gets the D&A information. There are three floors in the building that we purchased in Yarmouth, and two of the floors become available to us in three years, and the third floor could become available to us in five years, although there's actually a renewal option for the tenant there. So that's the way that breaks down. We currently have about 20,000 feet outside the primary building we have in Falmouth that we'd be happy to relocate there tomorrow if it were available to us, and even conservative growth projections would mean that we would need the majority of those two floors by the time they become available. So we don't expect to have -- that was one of the things that was attractive to us. We wouldn't expect to have low utilization at any point in time on that particular property.

And the depreciation on that building should be on an annualized basis a little forth of 300,000, about 318,000 a year. And how much lease income? Is that 300,000 per quarter in lease income you're getting? Is that right?

No, that -- yes, that sounds about right.

And then -- okay. And so the way you -- interest income, make it slightly above break even, on your last call?

Slightly better on a cash basis and more meaningfully better on an EBITDA basis.

At this time there appears to be no more questions. Mr. Marr, I will turn the call back over to you for closing remarks.

all right, Jason, thank you. We appreciate everybody's time. I think it's one of our longer calls, which is understandable in the time. If there are further questions feel free to call Brian or myself. Have a great day.

This does conclude today's teleconference. You may now disconnect, and have a great day.