Tyler Technologies - 10-Q quarterly report FY

(Exact name of registrant as specified in its charter)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.) Yes o No þ

Number of shares of common stock of registrant outstanding at July 25, 2006: 38,649,931

TYLER TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)

TYLER TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value and share amounts)

TYLER TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

Tyler Technologies, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(Tables in thousands, except per share data)

     The following table sets forth a comparison of our income tax provision for the following periods:

Risk-Free Interest Rate. We base the risk-free interest rate used in the Black-Scholes option valuation model on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term equal to the expected life of the award.

Expected Dividend Yield. We have not paid any cash dividends on our common stock in the last ten years and we do not anticipate paying any cash dividends in the foreseeable future. Consequently, we use an expected dividend yield of zero in the Black-Scholes option valuation model.

Expected Forfeitures. We use historical data to estimate pre-vesting option forfeitures. We record stock-based compensation only for those awards that are expected to vest.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model. We granted options for 97,590 shares and 45,000 shares for the three months ended June 30, 2006 and 2005, respectively. A summary of the weighted average assumptions and results for options granted during the three and six months ended June 30, 2006 is as follows:

The following table summarizes share-based compensation expense related to share-based awards under SFAS No. 123R for the three and six months ended June 30, 2006, which is recorded in the statement of operations:

The amount included in selling, general and administrative expense includes share-based compensation expense related to a non-employee consultant of $65,000 for three months ended June 30, 2006 and $112,000 for six months ended June 30, 2006.

At June 30, 2006 we had unvested options to purchase 1.8 million shares with a weighted average grant date fair value of $3.56. As of June 30, 2006, we had $4.8 million of total unrecognized compensation cost related to unvested options, net of expected forfeitures, which is expected to be amortized over the following periods:

As a result of adopting SFAS No. 123R on January 1, 2006, our income before income taxes and net income for the six months ended June 30, 2006, are $863,000 and $447,000 lower, respectively, than if we had continued to account for share-based compensation under APB No. 25. Basic and diluted earnings per share for the six months ended June 30, 2006 are both $0.01 lower than if we had continued to account for share-based compensation under APB No. 25.

As of June 30, 2006, we had options to purchase an aggregate of 4.4 million shares outstanding, and options to purchase an additional 959,000 shares were authorized for future grants under the plan.

Options granted, exercised, forfeited and expired are summarized as follows:

Other information pertaining to option activity during the six months ended June 30 was as follows:

The following table summarizes information about outstanding and exercisable options at June 30, 2006:

of which are currently confidential; however, management believes that the settlement agreement extends the non-compete for Oates and his related entities for some period of time.

We vehemently deny all allegations contained in the lawsuit. Management believes that we have not breached any non-competition covenants, have not solicited ACS employees, and have not misappropriated ACS confidential information. Management further believes that the “factual” allegations made against us are false and inaccurate and that the legal theories asserted by ACS are without merit. Management further believes, based on discovery that has taken place to date, that even if the allegations as currently set forth in the petition were true, ACS has suffered no or nominal damage, particularly in light of the settlement agreement with Oates and his related entities.

We have filed counterclaims against ACS, including claims for business disparagement and defamation, alleging that ACS has published factually inaccurate and defamatory statements about us to third parties, including our customers and prospective customers, with malice and/or negligence regarding the truth of those statements. We intend to defend the lawsuit and pursue our counterclaims vigorously. The future costs associated with such defense and in pursuit of the counterclaims are uncertain and difficult to predict and may be material.

Other than routine litigation incidental to our business and except as described herein, there are no material legal proceedings pending to which we are party or to which any of our properties are subject.

No material changes.

FORWARD-LOOKING STATEMENTS

The statements in this discussion that are not historical statements are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements about our business, financial condition, business strategy, plans and the objectives of our management, and future prospects. In addition, we have made in the past and may make in the future other written or oral forward-looking statements, including statements regarding future operating performance, short- and long-term revenue and earnings growth, the timing of the revenue and earnings impact for new contracts, backlog, the value of new contract signings, business pipeline, and industry growth rates and our performance relative thereto. Any forward-looking statements may rely on a number of assumptions concerning future events and be subject to a number of uncertainties and other factors, many of which are outside our control, which could cause actual results to differ materially from such statements. These include, but are not limited to: our ability to improve productivity and achieve synergies from acquired businesses; technological risks associated with the development of new products and the enhancement of existing products; changes in the budgets and regulating environments of our government customers; competition in the industry in which we conduct business and the impact of competition on pricing, revenues and margins; with respect to customer contracts accounted for under the percentage-of-completion method of accounting, the performance of such contracts in accordance with our cost and revenue estimates; our ability to maintain health and other insurance coverage and capacity due to changes in the insurance market and the impact of increasing insurance costs on the results of operations; the costs to attract and retain qualified personnel, changes in product demand, the availability of products, economic conditions, costs of compliance with corporate governance and public disclosure requirements as issued by the Sarbanes-Oxley Act of 2002 and New York Stock Exchange rules, changes in tax risks and other risks indicated in our filings with the Securities and Exchange Commission. The factors described in this paragraph and other factors that may affect Tyler, its management or future financial results, as and when applicable, are discussed in Tyler’s filings with the Securities and Exchange Commission, on its Form 10-K for the year ended December 31, 2005. Except to the extent required by law, we are not obligated to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. When used in this Quarterly Report, the words “believes,” “plans,” “estimates,” “expects,” “anticipates,” “intends,” “continue,” “may,” “will,” “should,” “projects,” “forecast,” “might,” “could” or the negative of such terms and similar expressions as they relate to Tyler or our management are intended to identify forward-looking statements.

GENERAL

We provide integrated information management solutions and services for local governments. We develop and market a broad line of software products and services to address the information technology (IT) needs of cities, counties, schools and other local government entities. In addition, we provide professional IT services to our customers, including software and hardware

installation, data conversion, training and for certain customers, product modifications, along with continuing maintenance and support for customers using our systems. We also provide property appraisal outsourcing services for taxing jurisdictions.

In January 2006, we acquired two companies, MazikUSA, Inc. and TACS, Inc. The combined purchase price for the two companies was approximately $14.6 million, comprised of approximately $11.7 million in cash and 325,000 shares of Tyler common stock. See Note 3 in the Notes to the Unaudited Condensed Consolidated Financial Statements.

As disclosed in Note 8 in the Notes to the Unaudited Condensed Consolidated Financial Statements we implemented the Financial Accounting Standards Board’s Statement of Financial Accounting Standard No. 123R, “Share-Based Payments.” In the three and six months ended June 30, 2006, the total share-based compensation expense was $504,000 and $975,000, respectively, or 1% of total revenue for both periods. The distribution of this expense for the six months ended June 30, 2006 was $902,000 to selling, general and administrative expense and $73,000 to cost of software services and maintenance.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements. These condensed consolidated financial statements have been prepared following the requirements of accounting principles generally accepted in the United States (“GAAP”) for interim periods and require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition and amortization and potential impairment of intangible assets and goodwill. As these are condensed financial statements, one should also read our Form 10-K for the year ended December 31, 2005 regarding expanded information about our critical accounting policies and estimates.

ANALYSIS OF RESULTS OF OPERATIONS

          Revenues

The following table sets forth the key components of our revenues for the periods presented as of June 30:

     Software licenses. Changes in software license revenues consist of the following components:

     Software services. Changes in software services revenues consist of the following components:

Maintenance. We provide maintenance and support services for our software products and third party software. Maintenance revenues increased over the prior year periods due to growth in our installed customer base and slightly higher maintenance rates on certain product lines.

Appraisal services. The appraisal services business is driven in part by revaluation cycles in various states. Appraisal services revenue increased over the prior year periods due to a large existing customer entering their next appraisal cycle as well as the addition of new customers.

          Cost of Revenues and Gross Margins

The following table sets forth a comparison of the key components of our cost of revenues, and those components stated as a percentage of related revenues for the periods presented as of June 30:

Cost of software license revenues. The main component of our cost of software license revenues is amortization expense for capitalized development costs on certain software products, with third party software costs making up the balance. Once a product is released, we begin to amortize over the estimated useful life of the product the costs associated with its development. Amortization expense is determined on a product-by-product basis at an annual rate not less than straight-line basis over the product’s estimated life, which is generally five years. Development costs consist mainly of personnel costs, such as salary and benefits paid to our developers and rent for related office space.

For the three and six months ended June 30, 2006 cost of software license revenues as a percent of revenues declined due to slightly lower amortization expense of software development costs as some products became fully amortized during the first quarter of 2006 and higher software license revenues.

Cost of acquired software. When we complete an acquisition we allocate the excess purchase price over the fair value of net tangible assets acquired to amortizable software, customer and trade name intangibles, with the remainder allocated to goodwill that is not subject to amortization. Amortization expense of acquired software is recorded as cost of revenues while amortization expense of other acquisition intangibles is recorded as amortization of customer and trade name intangibles. The estimated useful life of acquired software ranges from three to five years. In 2006, cost of acquired software increased compared to the prior year because we completed two acquisitions in late January 2006.

Cost of software services and maintenance revenues. For the three months ended June 30, 2006, cost of software services and maintenance grew 15% while the related software services and maintenance revenues increased 12% compared to the prior year period. For the six months ended June 30, 2006, cost of software services and maintenance and the related software services and maintenance revenues both increased 12% compared to the prior year period. Cost of software services and maintenance primarily consists of expenses, such as personnel costs related to installation of our software licenses, conversion of customer data, training customer personnel and support activities.

Cost of appraisal services revenues. The appraisal services gross margin increased for the three and six months ended June 30, 2006, mainly due to significant organizational changes and headcount reductions we made in the second quarter of 2005 to our appraisal services business to bring costs in line with expected levels of revenue.

Gross margin. Our overall gross margin for the quarter ended June 30, 2006 was 38.5%, compared to 37.2% in the quarter ended June 30, 2005. For the six months ended June 30, 2006 our overall gross margin was 36.6% compared to 34.5% in the prior year period. The gross margin rose mainly due to a revenue mix that included more software license revenues, as well as lower costs as a result of the restructuring of our appraisal services business in the second quarter of 2005. Software license revenue inherently has higher gross margins than other revenues such as software services and hardware.

          Selling, General and Administrative Expenses

The following table sets forth a comparison of our selling, general and administrative expenses (SG&A) for the periods presented as of June 30:

For the six months ending June 30, 2006, SG&A includes a non-cash purchased in-process research and development charge of $140,000 relating to one of our acquisitions in January 2006 and $975,000 of non-cash share-based compensation expense as a result of implementing SFAS No. 123R in January 2006. Offsetting these charges was lower SG&A relating to our appraisal services and appraisal and tax software businesses due to the restructuring of those businesses in the second quarter of 2005.

          Restructuring Charge

Because of unsatisfactory financial performance early in 2005, we made significant organizational changes in the second quarter of 2005 to those areas of our business that were not performing to our expectations. Our goal was to bring costs in line with expected levels of revenue while improving the efficiency of our organizational structure to ensure that clients continue to receive superior service.

We reorganized the appraisal services business to eliminate levels of management and reduce overhead expense. We also took actions to reduce headcount and costs in our appraisal and tax software division, and we consolidated certain senior management positions at the corporate office. These cost reductions were made in the second quarter of 2005. As a result, we eliminated approximately 120 positions, including management, staff and project-related personnel.

In connection with the reorganization, we incurred certain charges which were primarily comprised of employee severance costs and related fringe benefits, and totaled approximately $1.3 million before income taxes. The related payments were paid in 2005.

          Amortization of Customer and Trade Name Intangibles

Acquisition intangibles are comprised of the excess of the purchase price over the fair value of net tangible assets acquired that is allocated to acquired and amortizable software, customer and trade name intangibles with the remainder allocated to goodwill that is not subject to amortization. However, amortization expense related to acquired software is included with cost of revenues while amortization expense of customer and trade name intangibles is recorded as operating expense. The following table sets forth a comparison of amortization of customer and trade name intangibles for the periods presented as of June 30:

In January 2006 we completed two acquisitions which increased amortizable customer intangibles by $217,000. This amount will be amortized over five to seven years.

          Income Tax Provision

The following table sets forth comparison of our income tax provision for the periods presented as of June 30:

The effective income tax rates were different from the statutory United States federal income tax rate of 35% primarily due to the state income taxes, the qualified manufacturing activities deduction, non-deductible meals and entertainment costs and in 2006 the rate is also impacted by non-deductible share-based compensation expense. The effective income tax rate in 2006 is expected to be 39.9%. For the three and six months ended June 30, 2006 the effective rate declined compared to the prior year mainly due to changes in the Texas franchise tax law and rates enacted in the second quarter of 2006 and lower state income taxes as a result of a change in our corporate structure implemented in early 2005.

FINANCIAL CONDITION AND LIQUIDITY

As of June 30, 2006, we had cash and cash equivalents of $12.0 million and short-term investments of $10.5 million, compared to cash and cash equivalents of $20.7 million and short-term investments of $11.7 million at December 31, 2005. Cash provided by operating activities was $10.6 million in the six months ended June 30, 2006 compared to $7.2 million for the same period in 2005.

At June 30, 2006, our days sales outstanding (“DSO”) was 96 days compared to DSO of 101 days at December 31, 2005. DSO is calculated based on total accounts receivable divided by the quotient of annualized quarterly revenues divided by 360 days.

Investing activities used cash of $12.8 million in the first six months of 2006 compared to $2.8 million cash provided from investing activities for the same period in 2005. In January 2006, we acquired two companies, MazikUSA, Inc. and TACS, Inc. The combined purchase price for the two companies was approximately $14.6 million, comprised of approximately $11.7 million in cash and 325,000 shares of Tyler common stock. Other investing activities in the six months ended June 30, 2006 were primarily comprised of a liquidation of $1.3 million of short term investments and investments of $2.3 million in property and equipment. The property and equipment increase was due to expenditures related to computer hardware and software, including a new enterprise-wide customer relationship management system, and other asset additions to support internal growth. In the comparable prior year period, investing activities were comprised of a liquidation of $4.4 million of short term investments and

investments of $777,000 in software development and $885,000 in property and equipment. Capital expenditures were funded from cash generated from operations.

On February 11, 2005, we entered into a revolving bank credit agreement (the “Credit Facility”). The Credit Facility matures February 11, 2008 and provides for total borrowings of up to $30.0 million and a $10.0 million Letter of Credit facility under which the banks will issue cash collateralized letters of credit. As of June 30, 2006, our effective interest rate was 6.8% under the Credit Facility. As of June 30, 2006 we had no debt and outstanding letters of credit totaling $4.5 million to secure surety bonds required by some of our customer contracts. These letters of credit expire during 2006 and early 2007.

Financing activities used cash of $6.6 million in the first six months of 2006 compared to $9.9 million in the same period for 2005. Cash used in financing activities was primarily comprised of purchases of treasury shares, net of proceeds from stock option exercises and employee stock purchase plan activity.

During the six months ended June 30, 2006, we purchased 833,000 shares of our common stock for an aggregate purchase price of $8.3 million. We currently have authorization to repurchase up to 1.2 million additional shares of Tyler common stock. A summary of the repurchase activity during the six months ended June 30, 2006 is as follows:

The repurchase program, which was approved by our board of directors, was announced in October 2002, and was amended in April and July 2003, October 2004 and October 2005. There is no expiration date specified for the authorization and we intend to repurchase stock under the plan from time to time in the future. Our credit agreement includes a covenant which limits repurchases of our common stock to $20 million in any trailing twelve month period beginning after February 11, 2005.

We made federal and state income tax payments, net of refunds of $4.9 million in the six months ended June 30, 2006 compared to $3.2 million in the comparable prior year.

From time to time we engage in discussions with potential acquisition candidates. In order to consummate any such opportunities, which could require significant commitments of capital, we may incur debt or issue additional potentially dilutive securities in the future. No assurance can be given as to our future acquisitions and how such acquisitions may be financed. In the absence of future acquisitions, we believe our current cash balances and expected future cash flows from operations will be sufficient to meet our anticipated cash needs for working capital, capital expenditures and other activities through the next twelve months. If operating cash flows are not sufficient to meet our needs, we may borrow under our credit agreement.

Market risk represents the risk of loss that may affect us due to adverse changes in financial market prices and interest rates. As of June 30, 2006, we had funds invested in auction rate municipal bonds, which we accounted for in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” These investments were treated as available-for-sale under SFAS No. 115. The carrying value of these investments approximates fair market value. Due to the nature of this investment, we are not subject to significant market rate risk.

We have no outstanding debt at June 30, 2006, and are therefore not subject to any interest rate risk.

In order to enhance our ability to manage foreign currency risk associated with a contract denominated in Canadian dollars we contracted in December 2005 with a commercial bank to enter into a series of forward contracts, at no material cost to us, to acquire Canadian dollars through 2009 at fixed prices. These forward contracts have been entered into for periods consistent with the related underlying exposure in this contract and do not constitute positions independent of this exposure. If the applicable exchange rate was to increase or decrease 10% from the rate at June 30, 2006, our current risk management liabilities/assets would increase or decrease approximately $220,000. We do not enter into derivative contracts for speculative purposes, nor are we a party to any leveraged derivative instrument.

We maintain disclosure controls and procedures designed to ensure that we are able to collect the information we are required to disclose in the reports we file with the Securities and Exchange Commission (“SEC”), and to process, summarize and disclose this information within the time periods specified in the rules of the SEC. Based on an evaluation of our disclosure controls and procedures as of the end of the period covered by this report conducted by our management, with the participation of the Chief Executive Officer and the Chief Financial Officer, the Chief Executive Officer and Chief Financial Officer believe that these controls and procedures are effective to ensure that we are able to collect, process and disclose the information we are required to disclose in the reports we file with the SEC within the required time periods.

ITEM 1. Legal Proceedings

On September 9, 2005, Affiliated Computer Services, Inc. (“ACS”) filed litigation in Dallas County, Texas against thirty-three defendants, including Tyler and John M. Yeaman, our Chairman of the Board (“Yeaman”). The other named defendants include entities affiliated with William D. Oates (“Oates”), a former director of ours, and certain individuals employed by such entities. The lawsuit alleges, among other things, that we breached the non-competition and non-solicitation covenants set forth in the Stock Purchase Agreement dated December 29, 2000 (the “SPA”) between ACS and us pursuant to which we sold to ACS for cash all of the issued and outstanding capital stock of Business Resources Corporation (“BRC”), which comprised a significant portion of our then existing property records business. In the SPA, we agreed to certain five-year non-competition and non-solicitation covenants, which expired on December 29, 2005. In addition, the SPA contained a closing condition pursuant to which Oates agreed to amend his then existing three-year non-competition and non-solicitation covenants so that the restricted activities would conform to the language of our restricted activities, which covenants expired on December 29, 2003. The lawsuit alleges that Oates (or entities owned by Oates) solicited ACS employees and re-entered the land records business after the expiration of his three-year covenants, but prior to the expiration of our five-year covenants, and further alleges that we, through our non-compete, are legally responsible for Oates’ actions. The lawsuit further alleges that Oates “controlled Tyler”, “manipulated Tyler”, and was a “legal representative” of ours for a significant, but unspecified, period of time following the sale of BRC, even though Oates has not been a member of our board since 2001, has not been employed by us since the sale of BRC, has had limited contact with our management since the sale of BRC, and to our knowledge, has not owned any stock in us since May 2003. The lawsuit further alleges that we fraudulently induced ACS to enter into the SPA because we allegedly knew that Oates (or entities owned by Oates) would re-enter the land records business after three years, even though the SPA specifically contained different covenants with respect to Oates and us. ACS entered into a settlement agreement with all of the defendants other than Yeaman and us, the terms of which are currently confidential; however, management believes that the settlement agreement extends the non-compete for Oates and his related entities for some period of time.

We vehemently deny all allegations contained in the lawsuit. Management believes that we have not breached any non-competition covenants, have not solicited ACS employees, and have not misappropriated ACS confidential information. Management further believes that the “factual” allegations made against us are false and inaccurate and that the legal theories asserted by ACS are without merit. Management further believes based on discovery that has taken place to date that, even if the allegations as currently set forth in the petition were true, ACS has suffered no or nominal damage, particularly in light of the settlement agreement with Oates and his related entities.

We have filed counterclaims against ACS, including claims for business disparagement and defamation, alleging that ACS has published factually inaccurate and defamatory statements about us to third parties, including our customers and prospective customers, with malice and/or negligence regarding the truth of those statements. We intend to defend the lawsuit and pursue our

counterclaims vigorously. The future costs associated with such defense and in pursuit of the counterclaims are uncertain and difficult to predict and may be material.

Other than routine litigation incidental to our business and except as described herein, there are no material legal proceedings pending to which we are party or to which any of our properties are subject.

None

None

We held our annual meeting of stockholders on May 18, 2006. The results of the matters voted on at the meeting are as follows:

With respect to the amendment to our stock option plan to increase the number of shares of our stock that may be issued under the stock option plan from 7,500,000 shares to 8,500,000 shares, votes were as follows:

     With respect to the ratification of Ernst & Young LLP as our independent auditors for fiscal year 2006, votes were as follows:

ITEM 5. Other Information

None

ITEM 6. Exhibits

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: July 26, 2006