泰勒科技 (TYL) 2012 Q3 法說會逐字稿

Hello and welcome to the Tyler Technologies' Third Quarter 2012 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note that this event is being recorded.

I would now like to turn the conference over to John Marr, Jr. Mr. Marr, please go ahead.

Okay, thank you and welcome to our third quarter 2012 earnings call. With me on the call today is Brian Miller, our Chief Financial Officer.

First, I'd like for Brian to give the Safe Harbor Statement. Next, I'll have some preliminary comments. 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.

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.

John?

Our third quarter financial results extend our solid performance over the last six quarters, as this was our seventh quarter with year-over-year revenue growth. We're pleased with what we view as strong results for this quarter with overall revenue growth of over 21% and double-digit revenue growth in all of our software-related revenue lines.

Our organic business has returned to double-digit growth levels even with a higher mix of cloud arrangements. In our Infinite Visions business, which includes the Windsor, UniFund, and CSA acquisitions, all completed since last October, performed well in the quarter, contributing just over eight percentage points to our overall revenue growth.

We continue to see strong growth in our recurring revenues from subscriptions and maintenance, which together grew 24% and represented approximately 59% of total revenues for the quarter.

We are seeing continued growth and gradual improvement in the marketplace, which began to turn around about the middle of last year. The improved market, together with our strong competitive position, led to another quarter of strong bookings that were up 15% from last year.

Some of our notable recent contract signings include an arrangement with Sioux Falls, South Dakota's largest city to provide a wide range of MUNIS ERP solutions including financial management, human capital management, self service and content management; an arrangement with the West Contra Costa Unified School District in California, which is the 24th school district to choose our MUNIS ERP solution in California; agreements with the cities of Hayward, California and Gillette, Wyoming and Boulder City, Nevada, which signed a seven-year SaaS agreement for our MUNIS solution, and California's Palmdale School District has purchased our Infinite Visions ERP solution.

We also announced an agreement with the city of Converse, Texas, with multiple suites of Incode solutions including ERP, municipal courts, and public safety. In Colorado, we announced a contract with Boulder County for our Eagle Treasurer solution as well as a seven-year, multi-suite SaaS arrangement with Fremont County including Incode's ERP solution, Eagle Tax Assessment and Recording solutions. We've also signed appraisal service contracts with Santa Fe, New Mexico and Ashtabula County, Ohio.

On the product side, we continue to invest at a high level in developing efforts, building new products, and enhancing existing products. During the quarter, we announced the general availability of our Incident Management solution, which provides the software necessary for schools and transportation officials to record and manage school and bus incidents. Tyler Incident Management is flexible and a web-based solution that can be installed in accordance with school district's policies and procedures, enabling school officials to follow a consistent process for incident tracking.

We launched the Tyler Public Safety iPad application, which delivers mission-critical, computer-aided dispatch and convenient records management access to first responders. The Tyler Public Safety App is a true Apple application developed specifically to take advantage of unique Apple IOS capabilities.

We also announced the general availability of our Versatrans Pay-to-Ride solution, a payment management tool for school districts that must assess ridership fees. Demand for the Pay-to-Ride solution has grown recently as more school boards have decided to charge ridership fees to students' families as a way to help offset district transportation costs.

We completed our Windows 8 application for smart phones and tablets for use by field permit and code enforcement crews using the field inspector product.

Now, I'd like to turn the call back over to Brian to review our results. Brian?

Thanks, John. Yesterday, Tyler Technologies reported its results for the third quarter ended September 30th, 2012. You've seen the press release and the 10-Q has been filed this morning. So I'm going to provide some additional data on the quarter's performance then turn the call back to John for his final comments on the current quarter and our outlook for the remainder of 2012.

Revenues were $93.8 million, a new quarterly high, up 21.6%. Organic revenue growth was 13.1%, led by increases in our recurring revenues from maintenance and subscriptions as well as growth in our software services revenue. Our acquisitions of Windsor, UniFund, and CSA accounted for revenues of $6.6 million or 8.5 percentage points of growth.

Software license revenues grew 14.1% with 2.6% of that growth organic. We've now seen year-over-year license growth in three of the last four quarters following eight consecutive quarters of declines. This is particularly encouraging in light of the strong growth we've seen in our cloud-based business.

Subscriptions continued to be our fastest-growing revenue line and grew 41.9%. Organic growth was 37.7% and the impact of acquisitions was 4.2%.

We added 12 new subscription-based arrangements and converted 19 existing installed clients compared to a total of 12 new arrangements and 17 conversions in the third quarter of 2011. Approximately 23% of our new software customers in the quarter opted for one of our cloud-based solutions while 77% purchased a deployed solution with an associated perpetual software license.

The subscriptions line also includes a growing revenue stream from transaction-based revenues such as e-filing for courts and online payments. These revenues rose 48% to $2.6 million from $1.7 million last year. We expect to continue to see solid growth in these revenues as both new and current customers adopt our Odyssey File and Serve solution and more of them move towards mandatory e-filing. For example, Minnesota's two largest counties implemented mandatory e-filing effective September 1st.

Software services revenues increased 25.2% with 17.4% organic and 7.8% from acquisitions. Organic growth was primarily driven by the ramp up of work associated with implementation of contracts signed in recent quarters including the Oregon and Maryland courts contracts.

Maintenance revenue growth was 20.1% of which 9.7% was organic. Together, our recurring revenues from maintenance and subscriptions comprised approximately 59% of our total revenues and grew 24.0%.

Appraisal services revenues decreased 2.9% primarily due to the completion of a major revaluation project in Allegheny County, Pennsylvania. We are now underway with other new projects, including several in Ohio.

Other revenues included $269,000 of royalties on the sales of Microsoft Dynamics AX 2012 by other Microsoft partners in the second quarter. These royalties are recorded one quarter in arrears as the royalty reports we receive in a given quarter pertain to activity from the previous quarter.

Our blended gross margin for the quarter was a new quarterly high at 47.9% compared to 46.8%. The improvement was mainly driven by the blended software services maintenance and subscriptions margin, which increased 120 basis points, reflecting our operating leverage and incremental recurring revenues.

SG&A expense was 22.3% of total revenues, representing a decrease of 200 basis points from the same period last year.

Noncash stock compensation expense was $1.9 million compared to $1.6 million. $286,000 was included in cost of revenues and $1.6 million was included in SG&A expense.

Net research and development expense increased 1.8% to $4.3 million. R&D expense reimbursement recognized under our agreement with Microsoft in the third quarter of 2012 and 2011 was $1.0 million and $885,000 respectively. We do not expect to receive any further reimbursements under the agreement.

Net income was $10.8 million or $0.33 per share compared to $7.5 million or $0.23 per diluted share last year. The fully diluted share count declined by approximately 26,000 shares.

Our effective tax rate was 39.2%.

Free cash flow was $31.8 million, up 31.1% compared to $24.3 million last year. Excluding real estate CapEx, our free cash flow was $32.9 million versus $24.3 million.

Days sales outstanding and accounts receivable was 75 days at September 30th, 2012, an improvement of 13 days compared to 88 days at September 30th, 2011. This is also down from 99 days at June 30th as billings peak in June with a high level of maintenance billings followed by collections in the third quarter.

Our backlog at the end of the quarter was $357.9 million, up 19.8%. Backlog related to our software business, which excludes backlog from appraisal services contracts, was a record $328.2 million, an 18.3% increase. Backlog included approximately $109 million of maintenance compared to about $100 million a year ago. Subscription backlog was $80 million compared to $62 million last year.

Our bookings for the quarter, which are calculated from the change in backlog plus revenues, were up 15% to $92 million. For the 12 months ended September 30th, bookings were up approximately 19% over the prior 12-month period. We signed 16 new contracts that included software licenses greater than $100,000. Those contracts had an average license of $232,000 compared to 18 new contracts with an average license value of $277,000 in the third quarter of 2011.

Our total headcount grew by 37 to 2,276 employees at the end of the third quarter compared to 2,239 at the end of the second quarter.

Now, I'd like to turn the call back to John for his further comments.

Thanks, Brian. We're encouraged by the modest but continuing improvement in the marketplace as well as the improvement in our competitive position due in part to decisions to invest heavily in product development even as new business markets were generally weak. Last week, I had the opportunity to visit our Windsor office in Phoenix, the home of our Infinite Visions products. As you know, just a year ago this week, we acquired Windsor and in the following month followed up by acquiring CSA and UniFund, their two retailer partners. We are very pleased with their performance as well as their integration with each other as well as into Tyler. This process has been very well managed by our local government team as well as the Infinite Visions teams. I'm convinced we will exceed our expectations with this division for years to come.

Revenue from Microsoft Dynamics AX products continue to grow, although somewhat slowly. Both Tyler and other Microsoft partners are now actively selling Microsoft Dynamics AX and the pipeline is building. We have very little visibility into the Microsoft partner channel pipeline. And most of the early opportunities that Tyler is pursuing with the Dynamics solution have not yet reached the decision point. This quarter we recorded $269,000 of royalty revenues related to the Dynamics sales by other Microsoft buyers that were sold in the second quarter. That amount is a little more than the total royalties from the first two quarters combined. The royalties this quarter represent about -- represented from 23 clients in 13 different countries. Most of the sales by Microsoft partners in the first quarter have been upgrades from other Microsoft products, which do not carry a license royalty but do earn maintenance royalties for Tyler.

In addition, we had approximately $167,000 of revenues related to Tyler's direct sales of Dynamics. Year to date, our total royalty revenues are $518,000 and direct revenues are $584,000 for a total of approximately $1.1 million. We've consistently communicated our expectations that Dynamics will not generate meaningful revenues before 2013. We do, however, expect the revenues will continue to build and given that the majority of the cost associated with the product are relatively fixed and are in our current cost structure, we would expect that as royalties and license revenues build, we will see improvement in the contribution from these sales.

Courts & Justice is currently our fastest-growing division as our Odyssey product has a strong leadership position in the court space, particularly in the high end of the market. Our technology, our track record of successful implementations, and our high customer satisfaction contribute to this leadership position. We previously discussed a relatively new opportunity in the California courts market that has arisen out of the termination earlier this year of an unsuccessful project to build a statewide custom case management system. As a result, we expect that a number of California counties will be in the market for new systems. While we don't typically comment on awards prior to executing contracts, San Luis Obispo County recently posted a notice of intent to award Tyler a contract to implement our Odyssey system there. While we expect California will be a highly competitive market, we are encouraged to be selected in the first process since the cancellation of the CCMS project with evaluation scores that were significantly higher than other competitors.

In addition to our Courts & Justice, our new business pipeline is very active across all products with the volume near historically high levels. However, we believe the mix of new business in the fourth quarter will include a higher proportion of cloud contracts than previously expected and a few contracts will require deferred revenue recognition. For these reasons, we have slightly revised our revenue and earnings guidance for the year.

We currently expect 2012 revenues to be between $360 million and $363 million. We expect 2012 diluted earnings per share to be approximately $0.96 to $1.01. Fully diluted shares for the year are expected to be approximately $32.5 million to $33 million. For the year, estimated pretax expense related to stock options in the employee stock purchase plan is expected to be $7.5 million or approximately $0.17 per diluted share after taxes. We estimate an effective tax rate for 2012 of approximately 39.2%. We expect our total capital expenditures will be approximately $12.5 million to $13.5 million for the year. Total depreciation and amortization will be between $13.2 million and $13.7 million. Capital expenditures for the year include approximately $6.5 million related to real estate and office facility construction.

Now we'll take your questions.

(Operator Instructions) Nathan Schneiderman from Roth Capital.

I have a few questions for you. Just when you look at prospects for Microsoft royalty revenue, do you think about getting that number north of $1 million quarterly run rate? Do you think it's going to take until the second half of 2013 to get you there? Or is it likely to be sooner than that? Is this just in general looking like it's -- the Microsoft revenue flow is maybe looking like it's not going to move the needle here too much until we get to 2014 or am I misjudging that?

Well, not to give you a -- not to try to not give you a good answer is that we really don't know, Nathan. It is increasing steadily. The number of accounts increases, the footprint of the marketplace, 13 counties, 13 countries since last quarter. Activity we see. I don't see anything at Microsoft that they're discouraged by it. So, kind of those less tangible broad indicators that are still positive and there's still a lot of enthusiasm around it. The absolute number that we're booking certainly isn't that substantial. But it is growing and we really don't know. We'll get a report in a week or two that'll tell us how many sites and how many countries and what the dollars are for this past quarter now. As you know, the report we'll get and what we reported this quarter was for the second quarter. So there's a quarter lag there. That's only the third quarter of complete presence in the marketplace. But it's really hard to know.

I think that we should approach that number that you mentioned certainly sometime in the next few quarters, but it's hard to say. It'll be a little lumpy. Our direct sales, I mean we could win a significant deal sometime in the next few quarters and that would make it somewhat lumpy on our direct sales. But theirs will probably be more of a gradual and continued build.

But just in general, is this going maybe a little more slowly than you would have thought let's say maybe a year ago or is this just about what you were expecting?

Well, again, I didn't have real specific expectations cause they just wouldn't have been based on anything factual. We have, if you go back and look it our comments on this, we've always been cautious. We think this is an exciting project. We think it'll be substantial. But I've kind of said it, if you look at Odyssey today, which we're happy to report is doing well. It's going to have well above overall private growth experiences for the years coming forward. That product's approaching ten years in the marketplace now. I'm not suggesting this will take anything like that, but it takes -- that's a big success but it takes a long time to get to a point where you're a market leader and have consistent revenue. So, I think two or three years to build a book of business that's consistent and substantial is -- will be successful for a new product like this.

Just a follow -- since you mentioned Odyssey, I wanted to follow up with you on the California opportunity and maybe to make it a little more granular. If you look at cities or counties in California, how many of them would you expect to have a court's related RFP over the next year or just so to help us kind of get our arms around the potential opportunity?

Well, we'll be careful because as we said, we don't even normally -- San Luis Obispo is posted on the administrative office of the courts website and I think some of you have maybe reported on it. So we can go ahead and acknowledge that deal. I don't want to get in a situation where we're being too specific or granular about that. But, at least several. There are a couple active processes now. There's one multi site process underway. So, generally three to six decisions maybe in the next six or eight months.

Charles Strauzer from CJS Securities.

It's John Tanwanteng subbing in for Charlie. Thanks for taking my question and congrats on the quarter. Can you expand a bit on the sales cycle? Does it appear to be shortening yet and why or why not?

Yes, I'd say it probably is. Again, there were extra steps and considerations that were being added to processes during the 2009 and '10 timeline, in that environment. It probably has returned to be a little more normal. Decisions seem to be occurring on the process line that is published originally with the process. Again, for a couple of years it seemed like most of those processes were extending beyond that.

Okay that appears sustainable.

Hope so, I think so, yes. I think that probably local governments adjusted to the new environment that they're in. Projects that were delayed have gotten old enough that they need to be dealt with. Yes, I hope that and we seem to see that the decisions are being made a little more normally.

Then on the Microsoft business, any further data points to share on initial client implementations and how they've been going?

They've been going well and I think the good thing about the time it takes to ramp business in this business does also allow products to mature. So, what we did in Redman, which was our early adopter site, we threw a lot of resources at it, a lot of resources on our dollar. It's part of the early rollout. I think the product has already kind of matured through that process and we have a few small sites we're implementing now. Those are more normal and able to support themselves from mostly the contractual professional services in the arrangement. So, that's all good. The product's performing well. It demonstrates very well in the marketplace. I think as we win more business, we'll be able to execute those contracts more within the contract arrangement itself and not have to subsidize them as much as you would in earlier release products.

What are your plans for cash flow in 2013?

Well we haven't given 2013 guidance. We'll give that in connection with our fourth quarter earnings release. But we do expect as we -- it looks like 2012 cash flow will end up a bit above 2011. We do expect to see solid growth in cash flow, particularly with the growth in our recurring revenues, which generally are paid in advance that is a positive to cash flow from the deferred revenue growth. So we'd expect to see solid growth. But beyond that, we'll get more specific on the -- when we give our guidance.

Tim Quillin from Stephens Inc.

I just want to understand the fourth quarter guidance a little better because I think the full year guidance that you've narrowed a little bit implies 4Q EPS of $0.24 to $0.29, which is obviously down quite a bit quarter to quarter. I just want to know what the thought process is there?

There are a few things that affect that and as you'll note that the -- basically we narrowed the range for the year's guidance by a penny on each end. But essentially if you look at the midpoint, our guidance for the year has not changed. So the estimates that were on the street were a little bit flipped from our -- the mix -- the split between Q3 and Q4 from what we actually did. But when you look at the change from Q3 to Q4, there's a couple things. First of all, we had the $1 million of R&D reimbursement in Q3 that won't exist in Q4 or in future quarters going forward. So that's a couple cents difference on that item. We do expect to see lower services revenues and margins with lower utilization around the holidays in particular in some of our large projects like some large court deals where we're just not able to get the same utilization with the Thanksgiving and Christmas holidays.

We expect to see a bit higher SG&A. We had a couple of items in Q3 that won't be in Q4. We had lower incentive compensation, sort of had an accumulative catch-up there. We had -- as well as very favorable health costs experience over the last couple of quarters that was reflected in our Q3 results. We don't know what that'll be in Q4, but our guidance assumes normalized health costs there. Then the last item really is related to revenue recognition. As we get into the end of the year, it looks like that both Q3 and Q4 have a little bit more cloud-based business in the mix that we don't get to recognize revenues up front on obviously as well as the potential for a couple of contracts that are traditional deployed contracts that may have terms that cause us to either have deferred revenue recognition or percentage of completion accounting. Some of those are still in the works so we're not certain about it. But that little bit higher level of deferred revenue recognition and more cloud-based business in the mix contributes to that as well. So those all add up to kind of the reasons for that split between Q3 and Q4 being a little different.

Regarding that mix, you had previously expected software licensing to grow pretty nicely in double digits in 2012. Do you think software license revenue will still grow for the year?

I think our expectation for the year, yes, we had talked about low double digits in that just north of 10% range. I think now we're probably looking at mid single digit license growth.

Brian Kinstlinger from Sidoti & Company.

The first question I had is related to the California opportunity. I'm wondering if you've had discussions at all with the larger counties and maybe what their reaction was to your landslide victory in that small county? In addition, are you offering this in SaaS form or do you expect it'll all be in software license form in whatever you win in that opportunity?

I think there are mega counties. As you know, there are counties in California that are even bigger than a number of our statewide deployments. There are some of those that will be running a process, but as you might expect, their planning process and timeline will be longer than some of these smaller ones. So, I don't think you'll see mega counties in this mix two, three quarter cycle, probably more of a year and two year out timeline. So, I think that's what we're seeing there.

We will not dictate whether it's an on-premise traditional deployment or a SaaS arrangement. We'll put out either of those. At this point, it seems to me that most of their -- most of the counties that are active are looking for traditional arrangements. We do have the benefit of significant recurring revenue either way. Our maintenance fees and is really kind of a modified subscription arrangement anyway. We don't resell next releases. They're built into the fee. I think the recurring revenue will be significant either way. Obviously, we're hopeful to get our e-file solution a standard part of these arrangements, either initially or as a follow on, which is a very significant recurring stream for us as well. So, we're certainly conscious of creating relationships that are sustainable and allow us to deliver the value to that marketplace that they really need and obviously support our business needs over the long term.

Just to -- the other part of that question, have they communicated, those larger counties, in any way, shape, or form how you won that in the landslide and has that been a discussion with those, obviously those larger counties? Shows your functionality was so much better it showed and your pricing.

Yes, no and yes, I mean there's been other counties that have acknowledged that to us and congratulated us on that. I think we have our supporters out there. We'll be cautious. There are other capable companies obviously in that marketplace that want to get a piece of it. But obviously we won it in an objective scoring process significantly and it is published on the administrative office of the courts website. So it does represent something that the market's looking for more than some one-off process. So, we're encouraged by that but we certainly we'll take the competitive landscape seriously out there at the same time.

One question on Dynamics or two here together would be, maybe wanted to try to size the pipeline in any way we can. (A) is it growing? Is there a number you can quantify of rough proposals you're looking at or dollar value you're looking at over the next year to bid on?

Well it's growing and even though it's on a small number, I guess from a percentage standpoint, the royalties are growing significantly. Hopefully, we reach a more significant base and then those percentages continue. They're very actively engaged with their partners. I said 13 countries represented and we certainly expect that to continue to trend up and hopefully significantly. But, as was said, it's very hard to gauge and it wouldn't be responsible for us to guess at it and give you those numbers.

In terms of our direct sales, we have several dozen types of opportunities that we're pursuing. We've been fortunate to win a number of them. But unfortunately, they've tended to be smaller deals, $100,000, $200,000 license type fees. It's been good for us to win that business. It's good for us to now have three or four concurrent implementations going on to grow our own professional services group, to grow programmatic extensions groups and those sorts of things and kind of build the business around this. There are some larger deals in the pipeline but it's hard to predict if we'll be successful and when we'll be successful with those. But we certainly hope to and expect to win what are more significant deals as we go forward.

Last question I have is on e-filing. Just wanted to go back to the model. It's not much of a charge to your customer. If I understand they pay per transaction. First, am I right? Then second, so I'm interested in the operating margin contribution, if it's pretty much 100%. Then I'm interested and I asked this at the analyst day, trying to size the opportunity for you? What percentage of your clients have this and is it generally the larger customers of yours that don't have this that are going to implement this, you think like Minnesota? I think that you talked about. Just trying to gauge e-filing, please.

Yes, it is both. We have sold in the past licenses and maintenance arrangements. We certainly prefer the click approach. Because the clients really get to pass a lot of those costs onto the law firms and the users of the system, in this case it is much more popular with the clients than in our other lines of business. Our other lines of business, as you know, have kind of grown from the 15% adoption rate to maybe 30% through the recent environment. But this is at least an 80/20 situation. By far, there are more click-based arrangements and it seems to work better for both of us than purchasing a license, which is the model we prefer less.

We obviously have a number of Odyssey clients, large clients in states that didn't have this. We still just acquired this 2.5 years ago. So, yes, we have a lot of Odyssey clients that don't have an e-file solution in place. I think there's very strong interest. They had a customer forum just a few weeks ago that I attended and a number of those statewide clients and large counties are actively considering what they're going to do in this area. So I think our ability to leverage this into our install base as well as include it with future arrangements is really strong.

The growth opportunity here is significant. This has been successful and there's a high level of interest. People combining this with their case management system makes a lot of sense. So we're in a very good position on this. There will be investments we need to continue to make. Capital investments as we host and have facilities to manage this. In some of these large arrangements, there are help desks we have to create for the law firms that come in. There are programmatic extensions that sometimes have to be made in different states. So in some cases, I think we'll be talking about some investments ahead of the ramp up in fees that there certainly is a significant opportunity here with other statewide implementations and add-on's to some of our large counties.

Brian, they would high incremental margin types of revenues though because of the direct costs are generally credit card fees and then we've got a bucket of costs associated with the infrastructure, the help desk, the servers, the equipment, that sort of stuff.

You said $2.6 million of revenue this quarter. Is the opportunity to drive $30 million, $40 million of revenue there? Is that the opportunity or is it much higher in the long, long term obviously? Or is the opportunity there to double or triple it from there, which might not get you there? I mean I'm just trying to figure out penetration rates. Are you hardly penetrated into your client base yet?

I don't think we're hardly. There's a number of significant, Clark County's a big user. Mentioned Las Vegas and New Mexico and a number of clients are using it. But, yes, there's certainly an opportunity that a multiple of what our current business is. Putting brackets around that right now probably would be hard to do. But this is a significant growth opportunity.

Scott Berg from Northland Capital Markets.

A couple quick questions here. First of all, in terms of the buying environments. I picked up some data amongst a number of states where seems like tax receipts for the whole are up, which would indicate maybe a slightly improving buying environment for your customers. Are you seeing anything in terms of any of their habits or what you're hearing in terms of maybe RFPs that would maybe support that or not support that?

Yes, I think as we've commented, I don't think the market is all the way back to where it was pre-2009, but it has recovered. Decision processes are happening a little more normally on a little more of a normal timeline. I probably attribute a third of the improvement in our business over the last year, year and a half to a recovery in the marketplace. But the other two thirds and the more significant improvement I think is more based on our improvement in our competitive position. As the market weakened, companies either choose or couldn't continue to make the level of investments they might have wanted to in a different environment. We were able to and did and it's clearly differentiated us really across the board with our products. So I think we're benefiting more from that than the market recovered.

Then in terms of your guidance, I forgot if it was you or Brian that made the comments that you're seeing more customers choose your SaaS-based product here in the third quarter and into the fourth quarter. Do you think this is a permanent shift that you're seeing? Cause it's obviously not exactly in line with your expectations 90 days ago? Or is this maybe more transitory and we return to I guess levels you've seen more recently next year?

I think it's a trend that obviously could jump around a little bit. But I think that the idea of hosted solutions and arrangements obviously has gotten traction in the marketplace. The local government marketplace is slower to embrace those changes than the commercial marketplace. So we've been in this now for 10 years, 11 years and it's only in the last year, year and a half that those adoption rates have started to move from 12%, 15% to 25%, 30%. I would think over time that that is the trend that will continue, certainly if the broader markets continue to embrace that. We've also had a lot of success converting existing clients to hosted arrangements. Those have been successful. That word travelled throughout our customer base and there's a high level of interest in that. So we continue to expect to see that happen as well.

So with, along with our e-file solution, we grew our subscription-based business in the 30% plus range 2 previous years and you think of that basically as that that would lower on a percentage basis and this year it's going to be more around 40%. Pretty high, but really with the flips, the existing clients moving to hosted and with the adoption rate growing along with higher growth in our e-file business, we do expect that to continue to grow at a significant level. Not probably 40% on a year-over-year basis, but significantly above our company growth rates.

Scott, this quarter we had -- this quarter in terms of the adoption, the percentage of new customers was fairly similar to last quarter. But the mix this quarter, there were a few more of the larger deals whereas in prior quarters the cloud customers had tended to be more on the small side. That bounces around from quarter to quarter. But that part of it, the adoption rate hasn't increased a lot but the mix of the size of those customers has changed a bit.

Last question for Brian, your DSOs in the third quarter were much lower on a seasonal basis than I think I was expecting. Is that something that's sustainable going forward or will this be more of I guess a short-term anomaly?

Well, seasonally they do drop down, normally in Q3 because they spike in Q2 with the maintenance billing. So you get a lot of billings, but the revenues are recognized over the next four quarters. So they do and we do collect a lot of those fairly rapidly. So that leads to the strong cash flow in Q3. So it is seasonally. Normal that it drops but they are 13 days below where they were last year at Q3. We've seen a trend of improvement there. Some of that is a result of efforts on the collection side and trying to do a better job of tightening that up. I think the generally improving environment helps that a bit as well. A little bit less deferred payment terms that were a part of some of the contracts during more difficult new business environment. So, we certainly would like to continue to see that number come down year over year. But seasonally this is a normal trend.

Raghhavan Sarathy from Dougherty & Company.

Just a couple of questions from my end. First question is for John. John, you talked about pipeline remaining active. You have highest volume. Can you give us some sense for so year-on-year growth on pipeline through nine months? Also, as a follow-up, it looks like there's (inaudible) in the marketplace a competitive position that's improved. I was wondering whether we should see some acceleration in your organic revenue growth given factors?

Well we're not going to quantify the pipeline. It's kind of a competitive issue. But I think across the board, we're seeing some improvement in the size of the pipeline as well as the behavior of those processes, going on a little more normally. Obviously, the significant growth in pipeline would be more related to the court situation with the layer of California opportunities really adding significantly to their -- to the market footprint. Previously it was really that California didn't exist. Obviously, it's a big part of the market when that moves in. So that contributes significantly to that.

I'm sorry. What was the other half of your question?

Yes, the two things you mentioned were there's a recovery in the marketplace. Your competitive position has improved. If you look at organic growth rates so far there is about 10%. I was wondering whether these two factors could help to accelerate the organic revenue growth?

Now, of course, it has accelerated right. For two years we were relatively flat. We'll take the year that was flat and the year that was 5% or 6%. Now we're back in that 10%, 12% organic growth rate. We've got a bigger base than we used to have. So 10% or 12%, our company behaves pretty well. It generally starts to provide a margin opportunity again at that level as well. I think for most of our company, that's probably the right range for people to anticipate at a general level. We'll be more specific with guidance probably in January. But that's generally kind of the growth rate that we're expecting and targeting for the broader company. I do expect that Courts & Justice will grow above that trend line with the California opportunity being on top of what was already a pretty good pipeline for them.

So maybe if, maybe if I get some clarification. If you win some of the California opportunities is there an opportunity to accelerate from the 10% to 12% base level you're looking at?

Yes, a little bit. But let's remember, I mean there are a lot of $60 million, $70 million unit for us and another -- going from 10% to 20% growth for them obviously is only another $6 million or $7 million a year in business, which obviously is only a couple points on our overall business. So I think within the division they will grow more significantly. I think that'll provide an opportunity for them to have margin expansion over the long run. As I indicated earlier, they will have investments to make to prepare for some of these e-file arrangements where revenues ramp up after the investment you've made. But over the long run, that will be a significant opportunity for them. But again, as only 20 percentage of our overall business, even with a significantly higher growth rate, it's only a few percentage points on the whole company.

Then just one final question. You signed three or (inaudible) I think earlier this year. I was thinking that you would probably get a license bump in the third quarter or maybe fourth quarter. It seems like it's seeing more towards half. So Brian, can you help us understand where you are with that implementation?

Raghhavan, that's a percentage of completion contract and it is -- it will take place over multiple quarters. I'm not sure the implementation term but I think it's probably a six to eight quarter revenue recognition event. So the license -- it was an $8 million range kind of a contract with a few million dollars of license. That's again spread over multiple quarters. So there's some activity there. It started ramping up this quarter but the impact is -- it doesn't provide a real bump in any given quarter.

Final question. I'm not sure if you can comment on that but I was just curious when I looked at the San Luis Obispo County scoring, you had the highest bid yet you ended up outscoring your competitors even on price, which was a bit surprising to me. I was kind of wondering what (inaudible) makes that led you to even score highest on price quote as well?

I think a sophisticated buyer and they normalize those. So, if somebody bid very, very light services and it was clear there'd be more services required than were included in the bid. They made those adjustments to make sure that they were comparing apples to apples. So, I think our proposal was comprehensive. We have a good record of delivering within scope. I think they did their homework on that. So you're right. We ultimately scored better than what your first look might suggest.

Jon Ho from William Blair.

Just wanted to talk a little bit about the maintenance pricing. Have you guys seen a shift at all in terms of pricing or are we seeing this bounce back to normalized levels as it seems like the environment is improving?

There's always some pressure on it. There are some vendors in the new business market that I think have had trouble doing business on anything but cost. So they are in some cases being aggressive and sometimes it's something we have to respond to. We're pretty disciplined about it. We're pretty convinced obviously. It's in our customers' interest that with our evergreen strategy and long lived investments for them. There's a lot of value in our maintenance arrangement. So we do try to stand on it. But, yes, there'd be some stronger pressure. But again, these are long-term arrangements and clients are not going to pay for things they don't believe have the value associated with them that they don't necessarily select the lowest bidder either. They do select the system they think delivers the best value to them, which sometimes can be a more expensive solution.

Just in terms of your competitive wins, are you seeing this more at the higher end of the market that you've traditionally played in? Or is this at the low end? Or is this just across the board that you're just seeing the competitive wins pick up?

It's across the board. I mean we talked about Charlotte a minute ago. Obviously, the courts deal is a big deal. So we're doing somewhat better in larger arrangements. I think that's where we're very cost effective and generally less than the tier one players. But our local government division probably has the biggest increase on a percentage basis in bookings this year, which generally sells $100,000 to $300,000 arrangements. So it's across the board.

Just building on that, I mean do you feel like Tyler is now maybe distancing itself a little bit more from other competitors or potentially moving into its own category? Just as a nationally recognized player? Just want to get a sense of whether, at a strategic level, that's taking place?

You've got to be careful about that, obviously. We certainly aren't going to rest on any laurels but we're pleased and I think we have clearly established a leadership position across the board with these applications and really across the country, I know geographically. So, we're pleased with that. But, there are still very valuable competitors out there that are still tenaciously interested in the marketplace. We're going to certainly expect that they continue to invest and compete. But what we've done in the last couple of years in terms of market share, geography, size and range of clients, we are pleased with.

Mark Schappel from Benchmark.

Most of my questions have been answered. I do have one though and John I was wondering if you could just address whether there was a meaningful movement in RFP activity during the quarter that you saw?

No, it's more gradual than that. We don't think we could say. But again over the last three, four quarters, the pipeline has strengthened and things are behaving more normally. But there's no spike in the quarter, that's for sure.

Then with respect to the pipeline, wonder if you could just provide some additional commentary on what you're seeing with respect to the large deals in the pipeline? Whether you're seeing -- you're continuing to see movement toward the larger deals?

I think outside of courts, no. I don't think the mix in terms of size of clients is changing that much. There aren't that many Charlottes out there. There are many more of the half million, million, million and a half dollar deals that we often don't even mention. So, no, I think the volume in the pipeline is still in the mid range for our non-courts business. Obviously, the courts business are larger deals for us.

Tim Quillin from Stephens Inc.

I understand that the stars and the moons aligned pretty well for you in the quarter in terms of margins. But even if you exclude the Microsoft reimbursement out, you were at 18.8% margin. I mean how far ahead of ourselves should we get in terms of thinking about margin potential for 2013 and 2014? Is that kind of that kind of close to 19% range? Is that an achievable level in kind of the near to intermediate term?

Well I think that, as John said earlier, if we're growing in this low double-digit range, in the 10%, 12-ish percent range that we would generally expect to see gross margin improvement something north of 100 basis points and with the opportunity again, depending on the mix, depending on some of the recurring revenue growth, but the opportunity for a little bit higher than that. But we would expect to see 100, maybe 150 basis point gross margin improvement and potentially a little bit better than that on the operating margin line as we were able to leverage SG&A. We also believe that we'll be able to leverage R&D. Obviously over the last couple of years, we've significantly increased our investment in R&D. I think going forward over the next year or two, we have an R&D infrastructure in place at a around this level that'll continue to serve us well.

Then regarding the bookings outlook right now. In the fourth quarter of last year you had a court booking with Maryland that you drove the number, bookings number up quite a bit. I understand it's hard to predict lumps. But are there opportunities out there on the courts side where you could get to a similar level in the fourth quarter of this year?

Timing is hard to predict, but there are I think three statewide processes that we're engaged in. Probably only one of them the size of the Maryland and Oregon deals. So the timing is hard to predict. But there are some of those. Then again, probably beyond those processes you do have these counties in California that by themselves are comparable to mini states. So there are big deals out there but the timing of them will be very hard to predict.

I wouldn't expect that there'd be a Maryland size deal in Q4.

No.

Based on what we see now.

Brian Kinstlinger from Sidoti & Company.

Just one follow up. In regards to the Maryland and Oregon deals that you did sign, is there any timing of software license payments based on how you're accounting for that? Again, software license is flat. Those were some huge deals. So I'm just wondering is there a certain quota expect to bump or a fall off in software license.

They are recognized, both of those are percentage of completion accounting. So they're recognized over the implementation periods. They're five and six-year type implementations. So those licenses are spread over a number of quarters. Oregon is much farther along. They're not straight line over that period. So there's somewhat bell curve type spreads. Oregon is much farther along. I think Maryland is only a few percentage points complete. So we haven't recognized much license at all on Maryland yet. That'll be starting to ramp up in the coming quarters.

Courts & Justice I think had about a 20% to 25% increase in their license this quarter over last quarter. So, some of that Oregon is reflected there. But again those are spread over a number of quarters. They're not lumpy at all. So it's -- it doesn't move the needle as meaningfully in any given quarter. But it's in that base and it's replacing other business that -- in smaller contracts that finishes up.

So just to be -- just to understand, so in Maryland when it ramps up, will there be suppose their first point is 20%. When they hit that, will you get 20% of license in one quarter or --?

No.

Every quarter you gradually get a little piece of the software license.

It's the latter. It's recognized basically on percentage of completion basis, measured by basically the service hour deliverable. So as we provide hours.

As there are no more questions at the present time, I'd like to turn the call back over to Mr. Marr for any closing comments.

Okay, thank you and thank you for joining us on the call today. If you have any further questions, feel free to contact Brian or myself. Have a good day.

Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines.