Tyler Technologies - 10-Q quarterly report FY

 

(Exact name of registrant as specified in its charter)

5949 SHERRY LANE, SUITE 1400
DALLAS, TEXAS
75225
(Address of principal executive offices)
(Zip code)

(972) 713-3700
(Registrant’s telephone number, including area code)

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): Large accelerated filer o     Accelerated filer þ     Non-accelerated filer o

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 October 22, 2007: 38,870,335

ITEM 1. Financial Statements

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)

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 September 30:

The following table sets forth a comparison of gross margin percentage by revenue type for the periods presented as of September 30:

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 nine months ended September 30, 2007, our software license gross margin percentage increased slightly compared to the prior year period due to lower amortization expense of software development costs because some products became fully amortized during the first quarter of 2006. Additionally our product mix in the first nine months of 2007 included less third party software, which has higher associated costs than proprietary software.

Software services and maintenance revenues. Cost of software services and maintenance primarily consists of personnel costs related to installation of our software, conversion of customer data, training customer personnel and support activities. For the three months and nine months ended September 30, 2007, the software services and maintenance gross margin percentage was slightly higher than the comparable prior year periods because maintenance costs typically grow at a slower rate than related revenues due to leverage in the utilization of our support and maintenance staff and economies of scale. We have increased our implementation and support staff by 163 full-time equivalent employees since September 30, 2006. This increase includes 73 additional employees related to acquisitions completed in the first nine months of 2007. The remaining additions were to increase our capacity to train and deliver our contract backlog, particularly for our Odyssey courts and justice solutions.

Appraisal services. Higher revenues associated with increased activity on the Ohio revaluation projects contributed to the slight appraisal services gross margin percentage increase.

Our blended gross margin for the three months ended September 30, 2007 declined .8% compared to the prior year period due to a revenue mix that included less software license. Software license revenue inherently has higher gross margins than other revenues such as professional services and hardware. Although the revenue mix for the nine months ended September 30, 2007 also included less software license than the prior year period, the negative impact on the gross margin was offset by lower amortization expense of software development costs as well as lower third party software costs described above.

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

For the three months ended September 30, 2007, SG&A costs grew at a slower rate than revenues due to leverage in the utilization of our administrative and sales staff.

The following table sets forth a comparison of our research and development expense for the periods presented as of September 30:

For the three and nine months ended September 30, 2007, research and development expense included costs associated with the Microsoft Dynamics AX project, in addition to costs associated with other new product development efforts. In January 2007 we entered into a strategic alliance with Microsoft Corporation (“Microsoft”) to jointly develop core public sector functionality for Microsoft Dynamics AX to address the accounting needs of public sector organizations worldwide. In September 2007, we amended the agreement with Microsoft. Under the amended agreement, Microsoft will assist in funding our Microsoft Dynamics AX development costs in exchange for intellectual property rights for use outside the public sector. We are accounting for this funding from Microsoft as a funded development activity. In the three months ended September 30, 2007, we reduced our research and development expense by $880,000, which was the amount earned under the terms of the contract with Microsoft. We anticipate these costs and associated reimbursements from Microsoft will continue into 2009; however, the actual amount and timing of those costs and related reimbursements from Microsoft and whether they are capitalized or expensed, may vary.

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 software and customer and trade name intangibles. The remaining excess purchase price is allocated to goodwill that is not subject to amortization. Amortization expense related to acquired software is included with cost of revenues

while amortization expense of customer and trade name intangibles is recorded as a non-operating expense. The following table sets forth a comparison of amortization of customer and trade name intangibles for the periods presented as of September 30:

In the first nine months of 2007, we completed three acquisitions, which increased amortizable customer intangibles by $3.3 million. This amount will be amortized over a weighted average period of approximately 6 years.

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

The effective income tax rates for the three and nine months ended September 30, 2007 and 2006 were different from the statutory United States federal income tax rate of 35% primarily due to state income taxes, non-deductible share-based compensation expense, the qualified manufacturing activities deduction, and non-deductible meals and entertainment costs.

The effective tax rate for the three months ended September 30, 2006 included the benefit from previously unclaimed tax credits resulting from the completion of state income tax audits. The effective tax rate for the nine months ended September 30, 2006 also included the benefit of changes in the Texas franchise tax law and related rates enacted in the second quarter of 2006.

     FINANCIAL CONDITION AND LIQUIDITY

As of September 30, 2007, we had cash and cash equivalents (including restricted cash equivalents) of $20.3 million and short-term investments of $28.4 million, compared to cash and cash equivalents (including restricted cash equivalents) of $22.2 million and short-term investments of $19.5 million at December 31, 2006. As of September 30, 2007 we had outstanding letters of credit totaling $4.5 million to secure surety bonds required by some of our customer contracts. These letters of credit expire through mid-2008.

The following table sets forth a summary of cash flows for the periods presented as of September 30:

     Operating Activities

Net cash provided by operating activities continues to be our primary source of funds to finance operating needs and capital expenditures. Other capital resources include cash on hand and access to the capital markets. For the nine months ended September 30, 2007, operating activities provided net cash of $24.5 million, primarily generated from net income of $11.3 million, non-cash depreciation and amortization charges of $7.8 million, and non-cash share-based compensation expense of $1.7 million, and a net decrease in operating assets and liabilities of $3.7 million. The operating asset decline mainly relates to the timing of collection of annual maintenance renewals that are billed near the end of June.

Our days sales outstanding (“DSO”) was 93 days at September 30, 2007 and 102 days at December 31, 2006. DSO decreased compared to the fourth quarter of 2006 because of annual maintenance billing collections. Our maintenance billings typically peak in December and June of each year and are followed by collections in the subsequent quarter. DSO is calculated based on total accounts receivable divided by the quotient of annualized quarterly revenues divided by 360 days.

For the nine months ended September 30, 2006 operating activities provided net cash of $22.7 million, primarily generated from net income of $10.2 million, non-cash depreciation and amortization charges of $7.6 million, and non-cash share-based compensation expense of $1.5 million, and by a net decline in operating assets and liabilities of $3.1 million. The net decrease in operating assets and liabilities is attributable to timing of cash receipts related to annual maintenance billings.

For the nine months ended September 30, 2007, net cash used by investing activities of $20.0 million includes cash payments of $9.0 million for the acquisitions of EDP Enterprises, Inc., Advanced Data Systems, Inc. and certain software assets to enhance our courts and justice product line. In addition, investing activities includes $8.8 million, net of sales, to purchase short-term investments and $2.6 million in property and equipment. The property and equipment increase was due to expenditures related to computer hardware and software and other asset additions to support internal growth.

For the nine months ended September 30, 2006 net cash used by investing activities of $16.0 million includes cash payments of $12.2 million for two acquisitions, MazikUSA Inc. and TACS, Inc. In addition, we spent $3.3 million for property and equipment related to computer hardware and software, including a new enterprise-wide customer relationship management system, and other asset additions to support internal growth.

For the nine months ended September 30, 2007 and 2006, net cash used in financing activities was $5.9 million and $6.4 million, respectively, and was attributable to purchases of treasury shares, net of proceeds from stock option exercises and employee stock purchase plan activity.

During the nine months ended September 30, 2007, we purchased 889,000 shares of our common stock for an aggregate purchase price of $11.1 million. A summary of the repurchase activity during the nine months ended September 30, 2007 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, October 2005 and May 2007. On May 17, 2007, our board of directors authorized the repurchase of an additional 2.0 million shares of our common stock. As of September 30, 2007 we had remaining authorization to repurchase up to 2.1 million additional shares of our common stock. 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.

We made federal and state income tax payments, net of refunds of $6.9 million in the nine months ended September 30, 2007 compared to $7.9 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 be required to 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 believe that credit would be available to us.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk represents the risk of loss that may affect us due to adverse changes in financial market prices and interest rates. As of September 30, 2007, we had funds invested in auction rate municipal securities and state and municipal bonds, which were 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 these investments, we are not subject to significant market rate risk.

We have no outstanding debt at September 30, 2007, and are therefore not subject to any interest rate risk.

ITEM 4. Evaluation of Disclosure Controls and Procedures

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

As of June 30, 2007, we had warrants outstanding to purchase 1.6 million shares of common stock at $2.50 per share, which were held by Bank of America, N. A. (“BOA”) pursuant to the terms of two Amended and Restated Stock Purchase Warrants (collectively, the “Warrants”). The exercise price could be paid either in cash or by a “cashless exercise” in which the holder was required to surrender the Warrants in exchange for warrant shares based on the following formula: [(Market Price — $2.50) / (Market Price)] x 1. 6 million shares, with the Market Price calculated as the immediately preceding 60-day trading average of our common stock. The Warrants identified specific exercise procedures for each method of exercise and further provided that any exercise would not be effective until we received all applicable documents, instruments, and the purchase price. The Warrants were originally issued on September 10, 1997 and were exercisable from that date until 5:00 p.m., Central Time, on September 10, 2007, when they expired.

On September 10, 2007, at 4:44 p.m., BOA attempted to effectuate a “cashless exercise” of the Warrants via email; however, we believe BOA did not comply with all of the requirements set forth in the Warrants for an effective exercise. At 5:37 p.m., Central Time, BOA recalled this email exercise notice, which we subsequently accepted. At 6:10 p.m., Central Time, BOA attempted to effectuate a cash exercise of the Warrants by emailing a different notice of exercise, which we believe also failed to comply with all of the requirements set forth in the Warrants for an effective exercise, and in any event, was after the expiration date of the Warrants. As a result, we believe these Warrants expired as of September 10, 2007 and have excluded the effect of the Warrants from potentially dilutive common shares as of such date in our earnings per share computation.

On October 12, 2007, we filed a declaratory judgment action against BOA in the District Court of Dallas County, Texas, 101^st Judicial District requesting the court to declare, among other things, that the Warrants have expired pursuant to their terms. As of the date of this Form 10-Q, BOA has not filed a response to the litigation. While we believe the Warrants expired as of September 10, 2007, there can be no assurance as to the ultimate resolution of this matter.

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

ITEM 1A. Risk Factors

     No material changes.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

     None

ITEM 3. Defaults Upon Senior Securities

     None

ITEM 4. Submission of Matters to a Vote of Security Holders

     None

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: October 22, 2007