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Tyler Technologies, Inc. (NYSE:TYL)

Q4 2012 Earnings Call

February 7, 2013, 10:00 a.m. ET


John S. Marr, Jr. President, CEO, Director

Brian K. Miller – EVP, CFO, Treasurer


Nathan Schneiderman – Roth Capital Partners

Brian Kinstlinger - Sidoti & Company, LLC

Tim Quillin – Stephens, Inc.

Jonathan Ho – William Blair & Co.

Raghhavan Sarathy – Dougherty & Co.

Mark Schappel – Benchmark

Brian Kinstlinger - Sidoti & Company, LLC

Daniel Cummins – B. Riley & Co.



Hello, everyone, and welcome to today’s Tyler Technologies fourth quarter and year-end 2012 conference call. Your host for today’s call is John Marr, President and CEO of Tyler Technologies.

At this time, all participants are in a listen-only-mode, later we will conduct a question and answer session, instructions will follow at that time. As a reminder, today’s conference is being recorded, today, February 7, 2013.

Now I’d like to turn the call over to Mr. Marr. Please go ahead.

John S. Marr, Jr. 

Thank you, and welcome to our fourth 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 and Brian will review the details of our operating results. Then I’ll have some final comments and then we’ll take your questions. Brian?

Brian K. Miller 

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 projects. We would refer you to our Form 10K 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?

John S. Marr, Jr. 

Our fourth quarter financial results were solid and in line with our expectations. This was our eight consecutive quarter of year-over-year revenue growth. And we again, had double-digit organic growth of nearly 11%, in total growth of over 16%.

We were very pleased with the performance of our recent acquisitions. The Infinite Visions Product businesses, which include Windsor, UniFund, and CSA, performed well in 2012, and we’ve made substantial progress in consolidating those three organizations into Tyler.

Our most recent acquisition was EnerGov, was only included in our results for one month of 2012, but we are very excited about both the product and the people that have joined Tyler from EnerGov.

At the end of November, we completed the acquisition of EnerGov Solutions. They are a leading provider of enterprise, permitting, land management, licensing, and regulatory software solutions to government agencies.

EnerGov was founded in 2002, and is based near Atlanta, Georgia. This acquisition broadens our portfolio of Citizen Services software solutions, by complementing our Munis and Incode product suites, with industry leading land use and community development solutions.

EnerGov was selected in 2009, at the Esri World Partner of the year, and received the 2012 Esri Mobile App of the year award. EnerGov has clients in 31 states, and had approximately $9.5 million in revenue in 2012. The purchase price for EnerGov was approximately $10 million in cash, and $2.8 million in Tyler stock.

Our recurring revenues from subscriptions and maintenance continue to be the primary driver of our growth, as together they grew 22% and represented approximately 61% of total revenues for the quarter.

The trend of gradual improvement in our marketplace that we’ve discussed in recent quarters, appears to be continuing. However, we believe that our strong competitive position is the bigger factor in our growth, as we are seeing the results of the increased investments in product development we made, during the very challenging new business environment years of 2010 and 2011.

Some of our notable recent contract signings include the Texas Office of Court Administration, selecting our Odyssey File and Serve E-Filing offering for text file. A unified statewide electronic filing system for courts that will reduce the cost for filers, while providing a robust platform for the expansion of electronic filing in Texas.

In addition, the state of Oregon has begun implementing our electronic filing solution on a transaction revenue based model as well. Oregon selected our Odyssey Court Case Management system in 2010 for statewide implementation supporting all state trial courts.

Odyssey has all ready been successfully implemented in Yamhill, Cook, Jefferson, and Linn counties. The rollout of Odyssey to Oregon’s remaining circuit courts will continue through 2016.

The Superior Court of California, County of San Luis Obispo, signed a contract for our Odyssey system as the single integrated software for managing court information and operations within the San Luis Obispo Superior Court.

I’ll discuss both our eFiling business and the opportunity in California courts in more detail later in the call.

We signed two new clients for Microsoft Dynamics AX, through our direct channel during the fourth quarter, including Walker County, Texas, and the Maricopa County Association of Government in Arizona. I’ll also have more to say regarding this later in the call.

New clients for our Munis RT solutions include the city of Naples, Florida, Ellsworth, and Mt. Desert, Maine. Ellsworth is a traditional on-premise, and Mt. Desert signed a 10 year access agreement.

The city of Santa Barbara and Beverly Hills, were both significant contracts in California, where we continue to win a meaningful amount of new business. We also achieved a significant milestone where our Munis system is used by all of the school districts in the state of Kentucky.

In the fourth quarter, we completed the conversion of 173 school districts to our hosted solution from an on-premise installation.

In Texas, we signed a contract with almost $3 million with the city of Dallas, the nations ninth largest city for our Incode Municipal Court Case Management Solution. The city of Mesquite, which is also in the Dallas area, and is the state’s 18th largest city, will also implement our Municipal Court Solution.

In Mississippi, Jackson, the states capital city selected our Incode local government solution, including Criminal Court Case Management and Document Management applications. In the city of Gulfport, a long time client, added our public safety solution.

Significant signings for our CLT Appraisal Services include Cobb County, Georgia, with a five year $4.3 million contract for residential appraisal services, in Clermont County, Ohio.

Finally, in December, we signed an agreement valued at more than $2 million with Harford County, Maryland, for our recently acquired EnerGov planning, permitting, and licensing solution.

Now I’d like for Brian to provide more detail on the results of the quarter.

Brian K. Miller

Yesterday Tyler Technologies reported it’s primarily results for the fourth quarter ended December 31, 2012. These results are considered unaudited until our Form 10-K is filed, which is expected to be on February 20.

I’m going to provide some additional data on the quarter’s performance, then turn the call back to John for his additional comments on the current quarter, and our outlook for 2013.

Beginning with this quarter, we have added additional non-GAAP measures that we believe will facilitate understanding of our results, and comparisons with peers in the software industry. Our non-GAAP earnings excluded share base compensation expense, and amortization of acquired intangibles. A reconciliation of GAAP to non-GAAP measures, is provided in our earnings release.

Revenues for the fourth quarter were 95.4 million, a quarterly high and up 16.2%. Organic revenue growth was 10.9%, led by increases in our recurring revenues for maintenance subscriptions, as well as growth in our software services revenue.

Our acquisitions of Windsor, UniFund, CSA, and EnerGov accounted for revenues of $4.3 million, or 5.3 percentage points of growth. Software and license revenues declined 11.2%, excluding the impact of acquisitions, software licenses declined 18.9%. This is due in part to the mix of contracts, as the current quarter had several contracts with significant service components, which are recognized over a longer period, as well as the greater proportion of the new clients who choose a subscription based arrangement, versus the perpetual license.

Subscriptions continue to be our fastest growing revenue line, and grew 42.9%. Organic growth was 40.5% and the impact of acquisitions was 2.4%. We added 29 new subscription base arrangements, and converted 15 existing installed clients, compared to a total of 9 new arrangements and 12 conversions in the fourth quarter of 2011.

Approximately 45% of our new software customers opted for one of our Cloud base solutions, while 55% purchased the deployed solution with an associated perpetual software license.

The subscriptions line also includes the growing revenue stream from transaction base revenue such as eFiling for Courts, and online payments. These revenues rose approximately 50% to $3.0 million from $2 million last year. We expect to continue see solid growth in these revenues as both current and new customers adopt our Odyssey Filing and Serve Solution, and more of them move towards mandatory eFiling.

Software Service revenues increased 22.2%, with 18.7% organic, and 3.5% from acquisitions. Organic growth was primarily driven by the ramp-up of work associated with the implementation of contracts signed in the recent quarters, including the Oregon and Maryland Courts contracts.

Maintenance revenue growth was 16.9%, of which 10.1% was organic. Together our recurring revenues from maintenance and subscriptions comprised 61.1% of our total revenues, and grew 21.7%. And finally, appraisal services revenue increased 4%.

Other revenues included $238,000 of royalties on sales of Microsoft Dynamics AX, by other Microsoft partners in the third quarter. These royalty’s are recorded one quarter in arrears, as the royalty reports we receive in a given quarter, pertain to activity from the previous quarter.

In addition, we had approximately $256,000 of revenues related to Tyler’s direct sale of dynamics, which are included in licenses and services. For the full-year, our total royalty revenues were $756,000 and direct revenues were 840,000 for a total of approximately $1.6 million.

Our blended gross margin for the quarter was 46.8% compared to 47.5%. The blended software services, maintenance and subscriptions margin increased 50 basis points reflecting our operating leverage in incremental recurring revenues. However, this was offset by declines in software licenses and appraisal margins.

SG&A expense increased 7.7% in the quarter, and represented 23.9% of total revenues. A decrease of 190 basis points from last year’s fourth quarter.

Non-cash share compensation expense was $1.9 million compared to 1.7 million last year. 293,000 was included in the cost of revenues and 1.6 million was included in SG&A expense. Net research and development expense more than doubled to $5.4 million. We did not receive any R&D expense reimbursement under our agreement with Microsoft in the fourth quarter of 2012, versus 2.2 million of reimbursement in the fourth quarter of 2011. We do not expect to receive any further reimbursements under the agreement.

Operating income was $15.4 million compared to 14.3 million, or an increase of 7.7%. Non-GAAP operating income was 18.9 million, up 9.7% from 17.3 million, and our non-GAAP operating margin was 19.9%.

Net income was 9.4 to 11.3 million, or $0.28 per diluted share, compared to 8.7 million or $0.27 per diluted share. The fully diluted share count increased by approximately 1.4 million shares. Our effective tax rate was 37.6%.

Non-GAAP net income was 11.8 million or $0.35 per diluted share, compared to 10.8 million or $0.34 per diluted share in the fourth quarter of 2011.

Adjusted EBITDA, which is EBITDA plus non-cash share base compensation expense, was 20.3 million or $0.61 per diluted share, compared to 18.8 million or $0.59 per diluted share in the fourth quarter of 2011.

Free cash flow was 13.7 million, up 52.2% compared to 9 million last year. Excluding real estate CapEx, our free cash flow was 14.9 million versus 9 million last year.

For the full-year of 2012, our total revenue was 363.3 million, an increase of 17.4% compared to 309.4 million for 2011. Recurring revenues for the full-year grew 21.8% and comprised 59.6% of total revenue.

Net income for the year was 33.0 million, or $1.00 per diluted share, compared to 27.6 million or $0.83 per diluted share for 2011. Non-GAAP net income for the year was 42.4 million or $1.29 per share, an increase of 20.5% compared to 35.2 million or $1.06 per diluted share for 2011. Adjusted EBITDA for the year was 76.1 million, compared to 62.9 million in 2011.

Day sales outstanding in accounts receivable was 95 days at December 31, 2012, an improvement of 4 days, compared to 99 days at December 31, 2011. DSOs increased sequentially from 75 days at September 30, which is a normal seasonal pattern, as maintenance billings, and associated receivables spike in June and December quarters.

Our backlog at the end of the quarter reached a new high at 380.6 million, up 12.0%. Backlog related to our software business, which excludes backlog from appraisal services contracts, was a record 350.6 million, a 9.6% increase.

Backlog included 125.5 million of maintenance, compared to 110.3 million a year ago. Subscription backlog was 82.1 million, compared to 66.8 million last year. We currently expect to recognize approximately 42 million of the subscription backlog in 2013.

Our bookings for the quarter, which are calculated from the change in backlog plus revenues, were down 4.1% to 118 million. Bookings for the fourth quarter of 2011 included approximately $29 million from the Odyssey Court contract with the state of Maryland. For the 12 month ended December 31, bookings were up approximately 10% over the prior 12 month period.

We signed 18 new contracts in the fourth quarter that included software licenses greater than 100,000. And those contracts had a average license of $493,000, compared to 14 new contracts with an average license value of 866,000 in the fourth quarter of 2011. Excluding the state of Maryland contract in last years fourth quarter, the average license value for Q4 of 2011, was 474,000.

Our total headcount grew by 112 to 2,388 employees at the end of the fourth quarter, compared to 2,276 at the end of the third quarter. The acquisition of EnerGov added 70 new employees.

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

John S. Marr, Jr.

Thank you, Brian. As you can see, we returned to solid growth in 2012, after two years of a weak new business environment, and earnings for the year were generally in line with our expectations. I’ll detail our guidance for 2013 shortly, but first, I’d like to discuss in a little more detail some of our long-term opportunities, and our plans for this year as we prepare to build on those opportunities.

As you’ll see, we entered 2013 with expectations of another year of double-digit revenue growth, but our range of earnings growth and the implied margins associated with those earnings reflect some cost in margin pressure.

On a GAAP basis, share base compensation expense will increase significantly. While it is added back for non-GAAP income, share base compensation expense is expected to increase from 7.4 million in 2012, to approximately $10.5 million in 2013.

While we are reducing the number of options granted under our regular semi-annual grants, our very strong stock performance over the years has driven up the book expense.

Much of the additional cost in margin pressure is due to the investment we’re making in 2013, in advance of opportunities we believe will accelerate revenue and margin growth in 2014 and beyond. While margins will be relatively flat in 2013, it remains reasonable to assume that they will generally expand over time, even if not in a straight line.

One of the most significant of these investments is related to our electronic filing business, known as Odyssey File and Serve. This product allows attorney’s to file documents electronically with courts, providing significant efficiencies and cost savings for both the filers and the courts.

Most of our new eFiling contracts generate transaction based recurring revenues, where we provide the solution with little or no upfront cost to the courts, and earn revenues from filing fees. As a result, we generally incur implementation cost associated with the new contracts up front, and then build a stream of recurring revenues as eFiling volumes build.

Generally we look for the courts to make eFiling mandatory, in order to increase adoption, and achieve volumes that generate stronger margins.

As of the end of 2013, we have transaction based eFiling agreements that are currently generating revenues with only a handful of clients, three counties in Nevada and Michigan, in the states of Minnesota and New Mexico.

As I mentioned earlier, we have recently signed statewide eFiling contracts with the states of Oregon and Texas. In Oregon, we don’t currently have eFiling revenue, but the courts expect to mandate eFiling in each County, approximately six months after they go live on the Odyssey system.

In Texas, there is not a statewide court case management system, but we were awarded the statewide eFiling contract in November. The new [inaudible] system operated by Tyler, will replace a outdated existing system, which is expensive for user and capacity constrained, and eFiling is not currently mandatory anywhere in the state.

Very recently, the Texas Supreme Court, issued an order mandating eFiling in civil cases, beginning January 1, 2014. Mandatory eFiling will be phased in over a 2.5 year period, beginning with the largest counties in January of 2014.

We will be paid on a per filing basis. We expect to see very limited revenues from [inaudible] during 2013. During the coming year, we will invest significantly in the range of $3 million as we prepare to implement the system with courts across the state.

However, with the recent order mandating eFiling in Texas, we expect that this contract will provide a long-term recurring annual revenue stream of 15 to $20 million, when it becomes fully mandatory.

We are actively pursuing a number of additional eFiling opportunities, both with courts that are currently using Odyssey, and those that are not. With each new eFiling contract, we incur cost ahead of revenues, which can contribute to lumpy margin expansion. We believe that these recurring revenue streams are extremely valuable, and that this part of our business will contribute significantly in the coming years.

Now a relatively new opportunity that we’ve discussed in the last couple of quarters is in the California courts market, which arose out of the termination early last year of a project to build a statewide custom case management system. We are now seeing more activity in that marketplace.

As I stated in the opening remarks, we have been awarded the first decision to have signed a contract with the courts in San Luis Obispo County for our Odyssey Court Case Management System.

Tyler was also one of the three vendors recently selected in California, to enter into a master service agreement, under which courts in the state can purchase systems without going through the RFP process.

We are beginning to be engaged with a number of prospects that we expect to purchase the system under the master agreement.

While we continue to believe that the courts in California represent a great opportunity for which we are well positioned, we view this as a long-term process that will likely play out over a number of years.

These processes, especially the larger ones, can be lengthy and complicated, and we currently do not anticipate additional new contracts, that will contribute meaningfully to revenues before 2014. We will however be investing in development efforts in 2013, related to the California market, as well as cost related to increase selling efforts in the state.

Finally, California is not the only state we are competing for courts business, and we have a very active pipeline for Odyssey across the country.

I’d also like to add some color to our Microsoft Dynamics AX business. We started the year with very limited visibility on Dynamics business. Although we had no history on which to base our expectations for the year 2012, we did not expect the revenue contribution for the year to be meaningful.

Given the typically long sales cycles and the public sector market, we are not particularly surprised by the slow ramp-up of Dynamic sales. As you know, there are basically two channels from which we earn revenues related to Dynamics product.

First, there’s that direct sales channel. As we’ve previously discussed, our launch customer, the city of Redmond, Washington, went live with the product in July of 2011, and continues to be a strong reference. We announced two Tyler direct deals in the second quarter, and both of those clients are now live.

In the fourth quarter, we signed two additional direct deals that I mentioned earlier, Walker County, Texas and Maricopa County Association of Government in Arizona. In addition, we had two additional awards that are not yet signed, including one more significant deal, it was one of our early dynamic proposals.

We are encouraged by those awards and have a active pipeline of prospects that we are targeting with dynamics.

The second channel is from the Microsoft partners. We received royalties on both licenses and maintenance from dynamic sales in the public sector worldwide. We have very limited visibility into those partner channels, and record the royalty revenues a quarter in arrears. These revenues have grown slowly in the first four quarters, and royalties recorded in Q4 from sales in Q3 were actually slightly lower than the prior quarter.

The royalty’s recorded in Q4, however, represent sales in 12 different countries, and we are pleased with the geographical diversity of the partner channel, as well as by the run rate of recurring revenues.

In addition, a number of sales by Microsoft partners have been upgrade from other Microsoft products, which do not carry an initial license royalty, but will learn maintenance royalty’s for Tyler.

Since this year end earnings report is a few weeks later than our normal quarterly earnings, we have all ready received the royaty report for Q4, which will be recorded in Q1. Those revenues are considerably higher than the last quarter, and represent sales in 22 different countries.

While we are encouraged by the increase and activity reflected in the Q4 report, we expect that revenue through the channel may vary from quarter-to-quarter, until the base grows large enough for steady trends to develop.

We entered 2013 with a strong competitive position, a record backlog of business, and a business environment that appears to be continuing to trend in the right direction. With our growing backlog and positive outlook across the company, we are adding staff to ensure that we are well positioned to deliver on the new business levels.

Excluding the EnerGov acquisition, we added 79 people in the second half of 2012, and our plans call for a net addition of approximately 200 people in 2013, primarily in development and professional services.

While we carefully managing staffing additions, to insure that they are appropriately timed and in line with our business, the additions do put pressure on margins in the short-term, until these people are fully productive and generating revenues.

Our guidance for 2013 reflects those trends, as well as our continued investment in our products and business, that we believe will enhance long-term growth and margin expansion.

2013 guidance is as follows. We currently expect 2013 revenues to be between 409 and $418 million. We expect 2013 diluted earnings per-share to be approximately $1.06 to $1.14, and fully diluted shares for the year are expected to be approximately 34 to 34.5 million.

We expect 2013 non-GAAP diluted earnings per-share to be approximately $1.42 to $1.50. For the year, estimated non-cash share base compensation expense is expected to be approximately $10.5 million. We estimate an effective tax rate for 2013 of approximately 40%. We expect our total capital expenditures will be approximately 23 to $24 million for the year.

Capital expenditures for the year include approximately $14.8 million, related to real estate and office facility construction. Total depreciation and amortization is expected to be approximately 14.2 to $14.7 million, including approximately $6.5 million of amortization of acquired intangibles.

Now we’ll take your questions.

Question-and-Answer Session


(Operator instructions).


At this time, we'll begin the question and answer session. (Operator instructions).

And our first question comes from Nathan Schneiderman from Roth Capital. Please go ahead with your question.

Nathan Schneiderman – Roth Capital Partners

Hi, John and Brian. Thanks for taking my questions. It does sound like the eFiling initiative for courts is becoming pretty exciting. You referenced in your discussion opportunity on the Oregon side with eFiling. But I just wanted to clarify your initial $30 million dollar plus deal with Oregon. Did that anticipate eFiling revenues as part of that $30 million? Or would this be an incremental opportunity? And if it's incremental, could you scope it just in general or relative to the Texas deal?

John S. Marr, Jr.

No, it's part of the $30 million. And that really raises a point that should be clarified. Since these contracts are for a licensed or a professional service, it's a click type thing. They're never really any base contract. They don’t necessarily guarantee us this. And therefore, they're also not in backlog. So as TX file for example ramps up, even though as the mandatory counties come online, we see that ramping up to whatever, $15, $18 million. It will never be in backlog or part of the base agreement. So no, it wasn’t part of the $30.

That's a hard one to read because it's county by county after the counties go live. And I really don’t have any parenthesis for you on what that volume will be. We'll try to get that as it comes forward.

Brian Miller

The volume on that is I think about a half million filings a year. And as John said, that will ramp up over time. But so it's more in the $3 million annual run rate. It's not nearly the volume that Texas has.

Nathan Schneiderman – Roth Capital Partners

And then can you clarify as well? Did the $45 million Maryland deal anticipate – or I guess eFiling was not a part of that. Do you expect to get eFiling business there? And what would the size of that opportunity be relative to the Texas deal?

Brian Miller

We do expect to have eFiling in Maryland. It's not contracted yet. We're still in discussions. Maryland is still a fair ways away from being live and ready for eFiling. We do expect it will be on a transaction base. But it's not finalized. And so we don’t really have terms there. It is a much smaller state than Texas. And so the volumes would be significantly smaller.

Nathan Schneiderman – Roth Capital Partners

And then final question area for me, just on the court's license revenue at 1.5 million, a year ago, it was 1.9. And you have these $75 million of wins with Oregon and Maryland combined. When does that really start to flow into the license fee on the income statement in a meaningful way? And just why is the ramp so slow there? Thank you.

John S. Marr Jr.

We don’t expect that number to explode even though the contracts are significant and the growth in the business is significant. Sometimes what's in the contract doesn’t run through that revenue line. Anything that's carved out for professional services or any other place, maintenance, all comes out of the license fee. And that line does stay as you've seen kind of stubbornly flat as the other things grow.

Certainly, the strategy we have for the courts division is that as we benefit from these large contracts and certainly, they have a significant market opportunity there, we're much more focused on what the business looks like after we execute those contracts than during it. So the licenses will not grow as dramatically as one might think. And again, as we have to make choices in the structure of contracts and arrangements and negotiations, we will always be more focused on what the customer will look like after that initial implementation.

So we will see growth in that line. But it won't be anywhere near the growth you'll see in maintenance in the eFiling and the lesser degree of the professional services.

Nathan Schneiderman – Roth Capital Partners

Got it, thank you.


Our next question comes from Brian Kintslinger from Sidoti and Company. Please go with your question.

Brian Kintslinger – Sidoti & Company

Yeah, great to follow up on that last question. Thanks. On the software license, where are your expectations built into that line item for 2013 based on your guidance? And if it assumes any real growth double-digit, I guess what's the basis for that if we don’t expect to see that on the court's line?

John S. Marr Jr.

Yeah, and obviously, that's the hardest line to predict for a number of reasons. Obviously, much of the other businesses recurring has very high visibility. As you know, we have hardly any turnover in those lines. They are generally predicted on a very narrow range. And historically, we've been very accurate with those.

Licensing is difficult for two reasons. One is it's just hard to predict the timing of new business and the volume of new business. And then obviously, it's been complicated further for a good reason in recent years, which is that it's hard to predict how much of it's going to be SaaS or hosted recurring models, which we prefer to new license and traditional licensing arrangements.

All that said, we do have a fair amount of license growth in this year's budget. We won't do the breakdown dramatically. But certainly, double-digit and probably more in the 20% to 30% range. Some of that is acquisition obviously.

EnerGov is a new business. And still does a fair amount of traditional licensing. And their model is a newer company. A younger company is more business oriented in existing company and recurring revenue oriented. So they bring some of that. And there's still a tail on some of the acquisitions that weren't in all year last year. So probably about half of that growth is from acquired divisions, which really isn't growth. And then we do see growth across the different product lines as well.

So we do have in our plan more in the range of 20% to 30% license growth.

Brian Kintslinger – Sidoti & Company

Okay, and then thanks, on the eFiling, are there any of your existing customers that you can share with us that are deep into the Supreme Court process of mandating eFiling? I mean that's really the driver of this volume, not just actually signing up clients obviously. So maybe update us on the legislative landscape.

John S. Marr Jr.

Yeah, no, we've shared with you the ones that we thought have made that decision or far enough for us to do that. I want to be as transparent as I can with you folks. But I also don’t want to obviously get overly involved in ongoing decision processes and put things out ahead of what our clients are doing. But we thought that the Texas deal was significant enough that we should provide a lot of details in that. We have Oregon.

And I think certainly as we said, there are other states, other counties that we're actively engaged in. We do think this is an exciting part of our business. But I'm going to hesitate to get too granular with people that are still in the process.

Brian Kintslinger – Sidoti & Company

Great, I'll get back in the queue. Thank you.


Our next question comes from Tim Quillin from Stephens, Incorporated. Please go with your question.

Tim Quillin – Stephens Inc.

Hi, good morning. In terms of the implied margin guidance of roughly flat in 2013, can you talk about any specific cost drivers on that? You mentioned eFiling. Are there specific costs with the build-out of Texas that you could highlight? And then how much in terms of pursuing the California opportunities, how much of an increase in sales expenses would you expect?

John S. Marr Jr.

Sure, probably three specific things. And one of the reasons we've included non-GAAP guidance for the first time, stock compensation is up about $3 million year-over-year. We're committed to keeping the number of options we grant proportionately in line with the outstanding shares. Those will be coming down since we've repurchased a lot of shares in the last three years. Not the last year, but over a period of time. But the value of volatility of the stock have driven the cost per unit up significantly. So that's significant.

New acquisition intangibles is significant as well as we did four somewhat meaningful acquisitions in the last 18 months.

And then the textile thing itself, but also that as an example of the way our business does work. I think we indicated in the comments that that's about $3 million ahead of revenues. And that's a significant deal that by itself, we can appreciate that number, put some pressure on earnings.

But whether it's Oregon or other states, we're hiring people and creating teams and infrastructure to deliver on traditional deals that deliver on these [inaudible] filing and other hosted type deals. There's a range of investments we're making.

California is kind of anecdotal. That is not a $3 to $4 million number by itself. But it's another example of the great opportunity. There are some investments we should make in the product to have California specific extensions ready for our presentations and these implementations ahead of the deals. And they're obviously the sales and marketing effort there as well.

But the three big ones are the stock comp, the acquisition intangibles, and the Texas file deal. And then the fourth more general bucket as Brian said, we intend to add about 200 new heads in the year. Those people are all on board for many months before they're very productive in terms of generating revenues.

Tim Quillin – Stephens Inc.

Right, and then in terms of the master service agreement in California, how do you think about that in terms of accelerating time to revenue? Are you starting to see some opportunities you might have thought would go through a lengthy RFP process start to move quickly using the MSA? Or is it not quite so – maybe not moving quite so fast? Thanks.

John S. Marr Jr.

Yeah, no, we do believe that a number of counties that we are in discussions with have been looking to that to get finalized. They do intend to leverage that agreement rather than go through an independent process.

The courts are very organized with each other. So the San Luis Obispo deal I think really was somewhat of a template for this master agreement and for other deals. They do watch each other very closely.

So we feel good about our position. We're engaged with a number of counties that I think picture themselves utilizing that agreement, probably making decisions. And we would expect to have other arrangements in place this year. But as we said in the remarks, they probably won't contribute anything meaningful to 2013 results. But I think they will build our book of business going into '14.

Tim Quillen – Stephens Inc.

Thank you.


Our next question comes from Jonathan Ho from William Blair. Please go ahead with your question.

Jonathan Ho – William Blair & Company

Hey, guys. You talked a little bit about the environment again incrementally improving. Can you maybe characterize where we stand relative to a normalized environment? Is it now better? Or is it sort of in line with a normalized environment at this point?

John S. Marr Jr.

Yeah, no, it's not better. It's better than it was in 2010 and '11. Probably more because things that have been postponed become more urgent than the general environment being that much better. So it is better. People are – decisions are getting old enough that and urgent enough that they have to make these decisions. And some of the processes are moving forward more normally. But it's certainly not where it was prior to that marketplace.

And I think not just the activity we track, but something we're pleased with is, we're back to our regular low double-digit organic growth with nice acquisitions and tuck-ins and the company really performing the way it was prior to that environment.

If you look at the other companies in the space, that's the exception. Most companies are not back on a growth plane. Most of them are generally flat. Or in a lot of cases, off somewhat still at this point. So I don’t think everybody's enjoying a return to growth in what we have. And that’s why as we've said, we attribute our recovery more to our improvement competitively than the modest recovery in the marketplace.

Jonathan Ho – William Blair & Company

Got it, and just as a follow-up with regards to Microsoft. I mean why do you think things have kind of picked up in the fourth quarter on the license side? Is this time in channel? Is this just the sales force having more experience of the product or credibility? I'm just trying to understand a little bit better what your thoughts are around that opportunity and how you maybe see that shaping up for 2013.

John S. Marr Jr.

Yeah, you can look at this positively or not. The significant increase in the report that we just received that will be recorded in Q1 is largely driven by one deal. They had one very large deal in Indonesia. So as I said, you can look at that as you will. And as we said, this will probably continue to be a little lumpy until they really build up the channel enough to be more reliable.

Looking at it either way as I said, that it could mean that may not reoccur and it will continue to be choppy. But on the other hand, I'm encouraged because I know what's involved in winning a significant site. So that would have been retail. Obviously, our share isn't that, but retail of multi-million dollar license deal in a part of the world where we certainly have no exposure directly. And that's exactly what we're trying to do with dynamics is to get exposure to markets that we wouldn’t be in directly as well as to improve our presence in our own traditional markets. And it's encouraging to see them develop in a major enterprise deal competing with the tier one-type vendors. Bu they did have a very significant deal, which represented more than half of what that report will be.

Jonathan Ho – William Blair & Company

Excellent, thank you.


Our next question comes from Raghhavan Sarathy from Dougherty and Company. Please go with your question.

Raghhavan Sarathy - Dougherty & Company

Good morning. Thanks for taking my questions.

My first question is on the Texas eFiling opportunity. The court order from the Texas initially mandates the use of eFiling in civil cases and certain courts, but not in justice of municipal courts where the case volume is heavy. I know John, you said you're expecting between $15 to $20 million in annual return revenue. I'm kind of wondering what kind of case lowered our volumes is contemplated in that.

John S. Marr Jr.

That is strictly, as you said, the civil volume in those courts. That does not include anything from municipal courts or other courts that are not part of that mandate.

Brian Miller

And the current run rate right now or the current volume of filings in civil courts in Texas is about $6 million annually. And under the current system, only about 500,000 of those are currently filed electronically with the existing system, which not all counties use is not mandatory and is both expensive and capacity constrained. So that run rate for us moving up to $15 to $20 million in annual revenues is as you build up to that $6 million transactions that are currently the total for the state at the current level.

Raghhavan Sarathy - Dougherty & Company

And then can the product handle eFilings from adjustments in municipal courts? Is the potential for the revenue opportunity in case if it gets adopted or mandated?

John S. Marr Jr.

It could, but it is not contemplated under any of the arrangements we have now. The municipal courts are separate and entirely different. So it's just like this. We would have to go build interfaces and bring a system up. And it would be – it could do it, but it would be a pretty different project than the one we have in place.

Raghhavan Sarathy - Dougherty & Company

Okay, and just one follow-up. I'll jump back in the queue. You talked about eFiling being a material option for the year. And you said you don’t want to get into the details. But if you can step back from some of the details, how should we think about the total market opportunity for the eFiling business?

John S. Marr Jr.

I don’t think we're prepared to give too much. We don’t have visibility to know what that necessarily looks like. But we have as we discussed a number of counties, two states in place. We have Texas and Oregon coming on. We have a lot of our existing clients looking at that. Probably the accounts we're talking about, obviously Texas is a big part of that. There's a $30, $35 million a year recurring revenue rate. And certainly, it's a small percentage of where Odyssey exists. And we certainly can put this in place where Odyssey doesn’t exist.

So we look at this as a very significant opportunity that could be multiple of the business we currently can identify. Costs do grow as we expanded. But certainly, not proportionately to the revenues. So the next $10 and $20 million increments will be much higher margin than this initial investment that we make. But they are projects that do require resources at the same time.

So it's a significant growth opportunity. We're very focused on it. It's very important to make the right investments now and to deliver very high quality service so that we continue to benefit from that in the marketplace.

Raghhavan Sarathy - Dougherty & Company

Thank you.


(Operator instructions). Our next question comes from Mark Schappel from Benchmark. Please go on with your question.

Mark Schappel – Benchmark

Hi, good morning. John, with respect to the California Courts opportunity, I believe last quarter on the call, you thought that there could be three to six court decisions in the next six to eight months. I was just wondering if you think that’s the case, or if that’s shifted a little bit higher or lower?

John S. Marr, Jr. – President and CEO, Director

Probably still a relevant number, certainly not lower. I would think the three might be out of play, and maybe the brackets move up a little bit. We’re certainly engaged with, you know, the higher end of that range, or you know, say six or eight good names that we think potentially we might make decisions this year. But, as we know, timing is always hard to predict, but it’s an active pipeline.

Mark Schappel – Benchmark

Thank you, and as a follow-up; any big counties in the mix that you can comment on?

John S. Marr, Jr. – President and CEO, Director

You know, they’re not really the biggest counties. So, that’s a good question and so far these are not mega deals. These are, you know, $3 to $8 million kind of deals.

Mark Schappel – Benchmark

Okay, and then one question for you Brian. Last year, I believe, the Appraisal Services Group faced some margin headwinds, and I was wondering, what’s your outlook for margins in that group over this year?

Brian K. Miller – EVP, CFO, Treasurer

The business, we expect the Appraisal Services business to grow probably a high single digit this year. So they are seeing a little bit of growth with some cyclical projects coming back online in some of the States that have legislated cycles. But their at more traditional margins, so I’d expect them to be relatively consistent with this year’s margins.

Mark Schappel – Benchmark

Thank you.


(Operators instructions) Our next question comes from Brian Kinstlinger from Sidoti & Company. Please go on with your question.

Brian Kinstlinger – Sidoti & Company, LLC

Great, thanks. With the discussion on software license increasing roughly 20% ish, maybe more. Subscriptions growing so quickly, I still get the sense that you think gross margins will be flattish, and I’m wondering given the much better mix, which one of those factors drive that down and fully offsets that better mix of revenue?

John S. Marr, Jr. – President, CEO, Director

Well, as we’ve said, a lot of the expenses that are holding the margins flat aren’t necessarily related to revenues earned in the year. They’re the stock options expense, the (immunization) of new acquisition intangibles. Specifically the (tech) file investment $3 million by itself, and then, you know, a lot of smaller projects like (tech) file that – we won’t go into every name, but you know, create another bucket of expenses.

So, none of those are, you know, associated specifically with revenue mix or a particular revenue into 2013. Steps indicate the (tech) files we do see those revenues. The good news would be developing rapidly as we move toward 2014.

And I see this as a flat year, but the typical guidance we’ve given you guys in terms of the margin opportunity over the long-run, you shouldn’t look at any differently. This just happens to be a flat year, and there will be another year that’s a real strong year, and over your 3 and 5 year outlooks, this is not a change or any long-term trend. It’s just a year where there’s an opportunity to make some important investments and we’ll do that.

Brian Kinstlinger – Sidoti & Company, LLC

Okay. And then, the market seems to be regarding you more like a [inaudible] Company, and in the many years I’ve been looking at you, obviously you haven’t received the evaluations. And this is the first year in quite a long time, you haven’t really bought any or any significant amount of stock in probably the 10 years I’ve looked at you guys. So, I guess I’m wondering, do you expect that you will be more active in the market despite the revaluation and how the street has looked at your stock?

Or do you think there’s a better use of your cash flow over the next year or two?

John S. Marr, Jr. – President, CEO, Director

Well you’re right. This is the first – we’ve been almost 15 months without buying a stock. It’s the first time that’s happened since we’ve started buying our stock a little more than 10 years ago now. We’re fortunate; we bought a lot of our stock in the two years previous to that, which now looks like a good investment. We, you know, used some debt to do that. We’re at net cash of zero roughly today, so we have earned our way out of that.

We’re more disciplined in acquisitions these days than in the early years of building the company where there was more urgency to get to that leadership position. But even with that stronger discipline, I’m very pleased that we’ve been able to find the types of companies to join us, and the people, and the products that have come with them.

So, at this level of valuation, buyers probably shift to that direction. You know, we appreciate the reasons why our stock is training higher, but it does make it less compelling for us to be as aggressive there as we have done historically, and so that’s probably the way we’ll remain.

Brian Kinstlinger – Sidoti & Company, LLC

Great. Thank so much.


Our next question comes from Dan Cummins from B. Riley. Please get on with your question.

Daniel Cummins – B. Riley & Co.

Thank you. I wanted to ask about (follow on) sales, and how well you think the sales course is performing with respect to, you know the tier one business that you’ve done over the last two years. And the expansion of your product foot print, which seemed to position you pretty well to, you know, grow pipeline pretty aggressively, you know just based on (follow on) opportunities. Could you just give us a comment on that and how that might be, you know, in forming your plans to grow direct sales in the term? Thank you.

John S. Marr, Jr. – President, CEO, Director

Well, I think we’ve got the coverage we need. Now obviously a higher volume could require more resources. But I think we were probably – you know, probably had marginally bigger channel than we needed in 2010 and ’11. But these are very specific skills, we had a lot of long-term people in that channel and felt it was worth, you know, maintaining that level.

So, I really think our channel with a few, you know, few new positions here and there, has the capacity to deliver on the higher opportunity that we have in front of us at this point.

The market, as I said earlier, is better than it was in those years, but it’s not like it’s real robust. The nice thing about improving your market share is you’re not dealing with a higher level of [inaudible] and demonstrations in these things. You’re simply, you know, being more productive. And that’s a bigger part of what our growth is right now, than just addressing more deals.

Daniel Cummins – B. Riley & Co.

And then, if I could just a follow-up sort of related for Brian. In terms of just thinking about the seasonality of the first half here, are there any roll offs related to some of the big contracts. You know, leaving us any kind of little potholes on revenue in the next couple quarters we should be aware of? Thanks.

Brian K. Miller – EVP, CFO, Treasurer

Not specifically. We’ve seen that in the past a little bit in the appraisal business, and in the larger (Quartz) contracts, the two biggest ones are less than half complete, so there’s a lot of work left to be done. Those don’t finish up this year.

We always have contracts rolling off, and other ones rolling on, but there aren’t any real significant ones.

The first quarter generally is our lightest in terms of revenues, the holidays and the – some of the processes that our clients have going on in the first quarter, in January to end-of-year, tend to make it a little more difficult for us to execute as much as we are in other quarter. So, we do expect that the first quarter is the lightest in terms of revenues and earnings as well.

But as we’ve grown, the other quarters have become less seasonal and are more consistent with each other, so. But no specific large contracts that roll off.

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