Tyler Technologies, Inc. (TYL) Q2 2014 Earnings Report, Transcript and Summary

Hello, and welcome to today's Tyler Technologies Second Quarter 2014 Conference Call. Your host for today's call is John Marr, President and CEO of Tyler Technologies. [Operator Instructions] As a reminder, today's conference call is being recorded today, July 24, 2014. I would now like to turn the conference call over to Mr. Marr. Please go ahead.

Thank you, and welcome to our second quarter 2014 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, and Brian will review the details of our second quarter operating results and 2014 guidance. Then I'll have some final comments, and we'll take your questions. Brian?

Thanks, John. During the course of this conference call, management may make statements that provide information other than historical information that 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'd 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?

Thanks, Brian. Our second quarter financial performance was, by virtually any measure, the best quarter in the company's history. From a historical perspective, this was our 14th consecutive quarter of year-over-year revenue growth and our 11th straight quarter of double-digit revenue growth. Our GAAP net income of $14.7 million made this our most profitable quarter ever and was our 53rd consecutive profitable quarter. Our recurring revenues from subscriptions and maintenance continue to be major growth drivers, as together they grew over 20% and represented approximately 59% of total revenues for the quarter. Our subscription revenue growth of 51% reflects strong growth in our e-filing revenues from courts, as well as a continuing gradual shift toward cloud-based software as a service business. Software license and royalty revenues achieved exceptional growth again this quarter, up almost 20% over last year. This was our first $12 million license quarter and the third consecutive quarter where licenses and royalty revenues were greater than $11 million and grew year-over-year by 20% or more. The growth in license revenue is particularly noteworthy in light of the number of new SaaS clients we signed this quarter, which also reached a new high. Gross margin improved 150 basis points to 47.1%, reflecting our high level of software licenses, as well as the earnings leverage in incremental recurring revenue, especially eFileTexas. This quarter we recorded our highest quarterly bookings ever with bookings increasing more than 63% over the second quarter of 2013. While the new California courts contracts were major contributors to the bookings growth, signings were very strong across all of our major products. We signed 13 new California courts contracts in the second quarter, and our Odyssey case management solution has now been selected by 25 of the 28 California counties, with signed contracts for new case…

Thanks, John. Yesterday, Tyler Technologies reported its results for the second quarter ended June 30, 2014. Since our press release and 10-Q are both available, I'm going to add color around some of the key factors in the quarter and review our guidance for 2014, and then we'll move on to John's comments on the current quarter and our outlook for the remainder of 2014. In our earnings release, we have included non-GAAP measures that we believe facilitate understanding of our results and comparisons with peers in the software industry. Our non-GAAP earnings exclude share-based compensation expense, the employer portion of payroll taxes on employee stock transactions and amortization of acquired intangibles. A reconciliation of GAAP to non-GAAP measures is provided in our earnings release. Revenues for the second quarter were $124.4 million, a new quarterly high, up 20.6%, and all of our growth was organic. Software license and royalty revenues increased 19.8%. In Q2, we received $576,000 of royalties on public sector sales of Microsoft Dynamics AX 2012 by other Microsoft partners, down from $687,000 a year ago. In addition, we had approximately $1.7 million of revenues related to Tyler's direct sales of Dynamics, which are included across our various revenue lines. In Q2 2013, revenues from our direct sales of Dynamics were $216,000. Subscriptions continue to be our fastest growing revenue line and increased 51.0%. We added 44 new subscription-based arrangements and converted 21 existing on-premise clients, representing approximately $18 million in total contract value, compared to 28 new arrangements and 15 conversions in the second quarter of 2013. This was a new quarterly high for us in terms of new SaaS client signings, both in number and dollar value, as well as a new high in conversions. Approximately 27% of our new software clients this quarter opted…

Thanks, Brian. As I indicated earlier, we are very pleased with Tyler's second quarter performance, which is, by most measures, our best quarter in history. And as our revised guidance indicates, we have an increasingly positive outlook for the remainder of the year. Many of the factors contributing to our success this quarter have similar themes to last year. The local government market is active and has returned to prerecession levels. Most importantly, our competitive position is very strong across all of our major product suites, and our win rates continue to improve, which is enabling us to gain market share and expand our leadership position. As we noted earlier, Tyler achieved new highs in bookings and backlog this quarter. Our success in the California courts market, with 13 wins in the state this quarter, certainly was a major contributor. Timing of some of these contracts was accelerated in the quarter because some counties had time limits on the availability of funds. Although revenues for these contracts will be recognized over a number of years, the growth in backlog provides us with increasing visibility over future revenues. But our success and competitive strengths are much broader than just the California courts market. And even excluding the California deals, our bookings grew approximately 18% over last year's second quarter. In our court e-filing business, the efileTexas system continues to perform at a very high level. E-filing became mandatory in 12 more Texas counties on July 1. 77 Texas counties are currently live on eFileTexas, and our system is processing over 18,000 filings per day on behalf of its 75,000 registered users. We believe that eFileTexas can serve as a model for future e-filing systems in other jurisdictions across the country. With our Microsoft Dynamics AX relationships, results this quarter were again…

[Operator Instructions] And our first question comes from Scott Berg from Northland Capital Markets.

A couple of questions, John. How do you view pipelines right now given the strength in the quarter, even if you back out the anomaly in Courts & Justice deals in California? Obviously, you had a strong quarter across the rest of your businesses, but just trying to assess what those pipelines look like going forward and the potential opportunities there.

Pipeline beyond backlog?

Yes, pipelines beyond backlog.

Yes. Yes, nothing -- well, I shouldn't say nothing changes on June 30. The California anomaly, if you want to call it that, does cool down. A lot of them had a kind of a hard deadline to commit funds by June 30, so that did drive the 13 -- or having 13 decisions instead of whatever it would have been in California. Outside, though, of that, I don't see anything changing dramatically. I don't think that the other activity in the first half of the year, which was strong, changes dramatically as we go into the second half of the year. The market is healthy. As I said, it's back to prerecession levels. It's not particularly robust. It's just steady. But really, the higher levels of wins come mostly from our competitive position. The win rates are substantially higher than they were certainly a few years ago, and we continue to invest at a high level. This is not the result of a real high tide. All the players in this space are not getting these kinds of results. And I think that if we continue to invest the way we are, I don't see how our competitive position changes, again, as we go from one quarter to the next. So our expectation, outside of a little spike in California, is that it would remain at somewhere near this level as we go forward.

Okay, great. And then, John, as you look at the Dynamics revenues, obviously they're lower year-to-date on the royalty side, not your direct sales. But as you look at the remainder of '14, and I know your visibility is limited, but is there a scenario where those royalty numbers could actually be lower on a year-over-year basis?

From their channel, they could be. I don't know. I don't think we believe that will be the case, but they could be. As we've said before, we have very little visibility into that. This current quarter, which is what we'll book next quarter, is their year end and traditionally is strong. So we have a little more built into the third quarter. As we said, that's both a risk and an opportunity, so it's hard to tell really from their channel. In our own channel, we certainly have a reasonable amount of activity. We certainly expect to continue to close deals as we do that. We build a recurring base slowly, and we put a lot of the people to work that we've put into our service channel there. So there's still a lot of investment, not just in the R&D side, but now in the sales and service side that the new business will begin to support. So it's hard to say on their channel. We have very little visibility in our own channel, and there's a reasonable amount of activity.

Okay, great. And then last question for me, Brian. As I look at your individual line item results in Q2, your ESS software services revenues had a substantial sequential jump from we'll call it $22 million in Q1 to $27 million in Q2. Is that $27 million kind of sustainable throughout the rest of the year? I'm just trying to understand for modeling purposes. Or do we see a little volatility in that number which was so high in Q2?

I would expect that the level of services revenues, it was a little bit spiked this quarter. I'd expect that it would be, if you look at the next 2 quarters, maybe just slightly below that level, but not far off from that.

Our next question comes from Jonathan Ho from William Blair. Jonathan Ho - William Blair & Company L.L.C., Research Division: Just starting out with the California contracts. I just wanted to get a little bit more color. I know we've had a lot of announcements come out, but it doesn't seem like this is for the entirety of the system. So can you maybe give us a sense of, number one, is this all that you expect from -- in the current counties that you've won? And can you maybe quantify how much additional opportunity is there?

Yes, the -- every contract is different. So in some cases, it's for a number of case types, and in some cases, it's a single case type. But for the most part, the contracts aren't for everything. So there's certainly potential to add case types and expand the relationship beyond whatever the initial engagement is, in some cases substantially, in other cases, the initial engagement is more comprehensive. So I don't know that I can quantify that for you at this point in time, but certainly, there's opportunities beyond that. And as you know as well, eFile does not go into backlog. They're generally transaction based. They're not quantifiable. They're don't go into backlog. And even though they're a ways out, that, obviously, is a significant amount of business that's down the road. Jonathan Ho - William Blair & Company L.L.C., Research Division: Got it. And then just in terms of the win rates, I know you guys talked about that, outside of California being a bit stronger. Can you maybe give us a sense of how much that's picked up? Maybe talk a little bit about sort of the competitive landscape around Courts & Justice with some of the changes with your competitors and what you're seeing there.

Sure, although we won't get too granular because we spend a lot of time on our own sales intelligence and not for everyone else. But I think what you see in California, that we won all but 3 deals, is at least their win rate in meaningful deals around the country. So that's probably our highest win rate area of our business right now. They're very, very strong in relation to the competition, and I think we continue to strengthen in relation to the competition. And again, not necessarily drilling down to every single county in the country, but in these large counties, statewide deals, the more meaningful deals, I think the California experience where you have the numbers is reflective of their experience around the country. Obviously, there are more players. The market is a little more horizontal. It's a vertical market, but we see players crossing over from other markets in financials and human capital management and these other areas. So I think achieving that level of market share would be very difficult. But I would say we've -- to give you a general idea, that if we were at the 50%-ish level, half of the market, and the other half being split by a number of competitors in those areas, that experience has moved up pretty significantly from there, maybe another 20% or so, which is significant, especially when you look at the smaller share of the market that's being spread out among a number of players. And that's really reflective of, I think, the beat we're experiencing this year, that the market is generally what we expected. What was in backlog, our recurring revenues, it's a big part of our business. So really, if you look at the raise in revenues and earnings, that's really obviously coming from our new business slice of our revenue mix, which is really only 20%, 25% of our revenues. So it's a pretty significant difference.

And our next question comes from Charlie Strauzer from CJS Securities.

If you could talk a little bit, too, about your other competitor, AMK [ph], that went out of business recently and potentially the opportunity there of maybe if you have conversations with some of their customers but, more importantly, some of their key employees. As you're looking to ramp headcounts of qualified people, are you seeing some resumes from that transition?

Geez, we never thought of that, Charlie. Well, first of all, they didn't go out of business. There's a broader business there. They're in the recording business. They're actually still in the eFile business. So they have a few lines of business. They made a conscious decision to exit the case management business and shut that business down. And obviously, their clients and their employees are opportunities for us. So we're certainly aware of that and putting strategies together on how to be responsive to both of those opportunities for ourselves. I think that's a dramatic thing for somebody to exit the market entirely that was a very significant player just a few years ago. But I think it represents something that's less apparent that's going on in the market regularly, and that is that companies are consolidating. Relevant new business and new market companies are slowly becoming more legacy, and I think fewer players remain relevant in the new business market. And along with our own investments and improvements, that's all contributing to the increased market share across our product lines.

Great. And then shifting gears onto the appraisal side. You're starting to see the tide rise a little bit on appraisal again. And are you seeing kind of other opportunities like you're seeing in Indiana coming across the RFP pipeline at all?

Yes. I mean, that business is very predictable. So every state has their cycles. We know what they are. They've been in place. And we have pretty good visibility several years out. We do not expect and we don't necessarily even desire that, that become an explosive growth business or even a business that grows at our broader growth rates. So I would continue to look at that as a lower growth part of our business, manage it for quality, reasonable margins, another very sticky point with our marketplace.

Our next question comes from Mark Schappel from Benchmark.

John, starting with you. How many California court systems are live today?

Oh, I'd have to look. Obviously, none of the ones that have selected in the first half of this year are live. So it's a few, 3.

Really -- yes, at this point, Kings County is fully live. And I'm sorry, San Luis Obispo is fully live. Kings County goes live not very far down the road. But there's one that is fully in production.

Okay, great. And then with respect to the L.A. County contract, if I recall they had something in the order of, like, 10 different court systems. Does the contract include all 10 of the court systems?

You're talking about case types or different systems?

Yes, I believe, for example, they have, like, a juvenile court and a civil court.

Okay. So case types. No, it doesn't include all of the case types.

Is it fair to assume that those other case types will come up for bid later on down the road?

That's nothing we're certain of. That depends on their execution and relationship with their current solutions. The license fee actually does cover all case types. But the engagement in terms of services and certainly eFile would be expanded if other case types come up.

Okay. And then...

Maybe just civil, but it's not included, I believe.

Okay. And then one last question. With respect to the Massachusetts e-filing project, I was wondering if you'll just give us a little bit of an update on where that stands.

Well, the initial engagement in Massachusetts is strictly for a pilot, and we're in the process of implementing that. And the configuration is complete, it's loaded. We're doing the integration to third-party CMS solutions. And they do not have a specific go-live, but it might be somewhere around the end of this year. And then based on the performance of that project, the hope and expectation is that it will expand from the initial pilot.

Our next question comes from Kevin Liu from B. Riley & Company.

First question. Just on the California deals you secured this quarter, I imagine you didn't get that much in revenue from it and most of it would have fallen into services. So I was wondering if you could clarify the amount and if that is indeed the case. And then also, as we move forward here, how you expect that the revenues from these 13 wins to start to flow through? Do we see fairly stable services and license revenues recognized each quarter? Or are some of these are -- on later time frames where you wouldn't really expect too much in revenue until next year?

Yes, this quarter, we only recognized -- from the California deals we signed this quarter, we only recognized less than $1 million of revenue. And from all of the California contracts, including those signed in prior quarters in courts, we recognized a little less than $3 million in revenues. So relatively small related to the total volume of backlog. Those contracts have varying implementation schedules, some of them out as long as more than 4 years, in the case of Los Angeles. So we'll see them ramp up at various times. The licenses -- everything is a percentage of completion. The licenses are recognized pro rata as the services are earned. But we'll see them start to ramp up, but many varying schedules related to what are obviously a number of complicated engagements.

Got it. And then just with respect to headcount on the services side, I was wondering if you could talk a little bit about kind of your hiring plans for the remainder of the year. Do you expect to be hiring at the same pace that we've seen so far thus far? Or would you expect costs to start to normalize here?

Well, the hiring will accelerate in the second half of the year. I think we've said in our remarks we have about 200 heads in the second half planned. So pretty aggressive hiring. All of that -- in terms of people on board that aren't productive yet and the on-boarding costs, all of that is in our plan, which is reflected in our guidance. But we'll be adding heads aggressively in the second half.

And our next question comes from Alex Zukin from Stephens.

Two quick ones. The first, on the strength in the SaaS deals in the quarter, a really nice uptick on the amount of deals and the contract values. But then also, as a percentage, like, a little bit lower on a -- as a percentage of total. So can you just talk through kind of the puts and takes and how you view that number?

Yes, it does jump around a little bit. I think it was what, just under 30% of the deals. The number is up significantly because total awards was up significantly. And I think that's about right. I think that's kind of about where we are. And it may run a little higher, a little lower from time to time, but it's steadily building momentum and gaining traction in that space. It is not a clearcut shift from on-premise to cloud. I think the government market is slower sometimes to adopt these things. They're on-premise systems, the people they employ, those departments are very entrenched in local government. And as I've said before, often the catalyst for buying a new system is different than the catalyst to moving toward a SaaS or a cloud arrangement. So you see that we have a lot of what we call these flips where our -- I mean, we're thrilled to bring in an on-premise client even in today's cloud world. And often, down the road, maybe when they have a change in people that have worked there a long time or they require big infrastructure investments, some other catalyst causes them to move from an on-premise customer to a cloud customer. So I think it'll continue to be a slow build in our market, but that's a pretty good slice of our new business and that's probably about right in terms of expectation.

Got it. That's helpful. And then, Brian, one for you around the guidance for revenue growth in the second half. It looks like it's a slight deceleration from where we've seen in the first half. Can you talk about maybe is that conservatism or around how you're thinking of the timing some of these deals coming into the pipe?

Yes, I think it's our assessment of how we ramp up to some of this new business. And actually, revenues grew quite a bit in the second half of last year. So the comparison is a little bit tougher. So the growth rate decelerates a little bit, but still looking at a solid north of mid-teens kind of growth for the year. The services was at a high level this quarter. That'll continue to ramp up as we bring resources online. Licenses, I think, we would expect to be kind of in this range in the rest of the year. And as we said, margins, we would expect on a gross margin basis to be in a similar range to where we were this quarter. Obviously, we saw very strong margin growth year-over-year. But as we bring these people on board and absorb those costs, it'll probably plateau a little bit around this gross margin range for the next couple of quarters. But part of that just has to do with a tougher comp from the growth we saw starting in the second half of last year, particularly as eFileTexas started revenues in Q4 of last year. So that's been a -- that obviously is a big contributor to the revenue growth this quarter and last.

[Operator Instructions] Our next question comes from Matt Williams from Evercore.

One that might be a little difficult to quantify and I've realized that up front, but given the strong bookings and backlog associated with the California deals primarily, is there any color that you can provide around sort of the duration, maybe specific to the California contracts? And then the duration of that backlog on an average basis of the deals that aren't associated with California? So essentially, I was just trying to get a sense of timing of when we can, from a modeling standpoint, start to expect some of this stuff to roll through. And I realize it's obviously different on a county-by-county basis.

Yes, I think our general -- as Brian indicated, our revenues in the second quarter were pretty insignificant from California. There's a tremendous amount of activity in the market and they had a big effect on bookings and backlog, but still not that significant in our financial statement. And that'll start to build in the second half, and it'll be a significant contributor really over the next 3 to 5 years, the business that we're doing there. And I think there will always be another market, but that is a bit of an outsized market. So there may not be other deals that completely replace that new business as it runs off a few years -- starts to run off a few years out. That said, I think the follow-on in California, as the maintenance agreements come into place and then followed by e-filing beginning to ramp up, the revenues will be replaced by recurring revenues and new business in other places. And while that may not support this level of growth, I wouldn't look for this level of growth on an ongoing basis, it will provide a favorable revenue mix and a margin opportunity as recurring revenues are generally more profitable than new business revenues.

And I guess maybe a quick follow-up on that sort of second point there. The e-filing opportunity over the longer term seems to be particularly compelling from my point of view. For the California counties that are contracted for the court case management side of things, is there an opportunity for them to sort of go live with e-filing ahead of the broader Odyssey implementation? Or is it a case of Odyssey needs to get set up and implemented before e-filing can really start to flow through for those counties?

Yes, I think anybody going live with e-filing ahead of having their case types up would be isolated. Generally, you should think of it as a follow-on to the implementation and the go-live for the case types.

And ladies and gentlemen, at this time, I would like to turn the conference call back over to management for any closing remarks.

Okay, thank you and thank you all for participating in our call today. If you have any further questions, feel free to contact Brian or myself. Thanks again. Have a great day.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your telephone lines.