Hello, welcome to today's Tyler Technologies third quarter 2015 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, and instructions will follow at that time. As a reminder, this conference is being recorded today, October the 22nd, 2015. I would like to turn the call over to Mr. Marr. Please go ahead, sir.
Thanks, John. 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 third quarter operating results and give 2015 guidance. I'll have some final comments, and we'll take your questions. Brian?
Thanks, John. During the course of this conference call, management may make statements that provide information other than historical information and may include projections concerning the company's future prospects, revenues, expenses, and profits. Such statements are considered forward-looking statements under the safe harbor provision of the Private Securities Litigation Reform Act of 1995 and are subject to certain risks and uncertainties, which could cause actual results to differ materially from these projections. We would refer you to our Form 10-K and other SEC filings for more information on those risks. Please note that all growth comparisons we make on the call today will relate to the corresponding period of last year unless we specify otherwise. John?
Thank you. Our third quarter financial performance was very solid, with double-digit growth in all revenue lines. From a historical perspective, this was our eighth straight quarter of revenue growth greater than 15%. In six of the last seven quarters, revenue growth has exceeded 17%. Software license and royalty revenues were up nearly 19%, and at $15.7 million were the highest in company history. Continued strong growth in our e-filing revenues from courts, as well as a gradual shift toward cloud-based software as a service business, led to 28% growth in our recurring revenues from subscriptions. We had a very solid quarter for bookings, which rose almost 26%. On a trailing 12-month basis, bookings grew 6% in a difficult comparison because Q2 of last year included bookings of approximately $64 million related to contract signings with California courts. Excluding the California courts contracts, the trailing 12-month bookings rose 18%.
Two of our largest new contracts signed during the third quarter included our iasWorld Appraisal and Tax Administration Solutions. The largest was a $30 million agreement with Cook County, Illinois. The integrated solution will replace 40-year-old technology used by the county's offices of the assessor, clerk, treasurer, board of review, and the Department of Geographic Information Systems. The county selected multiple Tyler software solutions to meet its property tax administration needs, including CAMA, Tax, Field Mobile for collecting and reviewing information in the field, Public Access for online access to property and tax data, and Tyler Content Manager. Cook County has more than 800 local government parcels and a population of 5.3 million. The county, with 128 municipalities, is the second most populous county in the U.S. and includes Chicago, the third most populous city in the U.S.
We also signed a multi-suite, five-year SaaS contract with Lake County, Illinois, for our iasWorld Appraisal and Tax Administration solution and our EnerGov planning, regulatory, and maintenance platform, valued at approximately $8.5 million. We signed two significant agreements for our EnerGov solution during the quarter. The first was with Los Angeles County Department of Public Works in California, valued at approximately $9 million. This was a follow-on agreement to our initial EnerGov contract with the Los Angeles County Department of Regional Planning in 2014. The second contract was with Boulder, Colorado. It is valued at approximately $1.6 million and is a follow-on agreement to our initial contract in the fourth quarter of 2014.
We signed several notable contracts in Texas for our Munis ERP solution, including on-premise contracts with Hays Consolidated Independent School District in the city of League City, and a SaaS contract with Coppell Independent School District. We also signed new SaaS agreements for Munis, each worth more than a million dollars, with Madison County, Tennessee; Williamsburg-James City County Public Schools, and Wythe County, all in Virginia; in the city of Benicia, California; and the Allegany County Public Schools in Maryland. For courts and justice, significant contracts in the quarter for our Odyssey solution included an on-premise agreement with Potter County and a SaaS agreement with Karnes County, both in Texas. Also, three California counties, Santa Cruz, Alameda, and San Diego, all signed e-filing contracts as a follow-on to their 2014 court case management agreements.
We signed a significant agreement for our Eagle Recorder solution with Santa Clara County, California. As you know, on September 30th, we signed a definitive agreement to acquire privately held New World Systems Corporation for $670 million in cash and stock. New World Systems, a leading provider of public safety and financial solutions for local government, will bring an important element to our portfolio of solutions. Founded in 1981, the Troy, Michigan-based company has over 2,000 public sector customers and more than 470 employees. New World Systems is highly complementary to Tyler, and the combination supports our strategy of being an industry leader in all major enterprise applications essential to local government. New World Systems' principal products are Aegis, a comprehensive public safety suite for dispatch centers, police officers, firefighters, paramedics, correction officers, command staff, and all first responders.
Logos, a suite of public administration software that meets the accounting needs of city and county governments. Public safety represents approximately 67% of New World Systems' revenues. Under the terms of the agreement, we will acquire all of the equity of New World Systems for $360 million in cash and approximately 2.1 million shares of our common stock. The cash portion of the purchase price will be funded from cash on hand and proceeds from a new revolving credit facility. The transaction is expected to close in the fourth quarter of 2015 and is subject to regulatory approval and customary closing conditions. This transaction is expected to be immediately accretive to Tyler. I'd like for Brian to provide more detail on the results for the quarter and update our annual guidance for 2015.
Thanks, John. Yesterday, Tyler Technologies reported its results for the third quarter ended September 30th, 2015. I'm going to provide some additional data on the quarter's performance and review our guidance for 2015. John will have some additional comments on the quarter and our outlook for 2015. In our earnings release, we have included non-GAAP measures that we believe facilitate understanding of our results and comparisons with peers in the software industry. Our non-GAAP earnings exclude share-based compensation expense, the employer portion of payroll taxes on employee stock transactions, acquisition-related costs, and amortization of acquired intangibles. A reconciliation of GAAP to non-GAAP measures is provided in our earnings release. Revenues for the third quarter were $150.8 million, up 17.2%, with 15.7% organic growth. Software license and royalty revenues increased 18.6%, and at $15.7 million, were the highest level in the company's history.
This was our 11th consecutive quarter of double-digit growth in licenses. In those 11 quarters, all but one have had growth of over 16%. In Q3, we received $1.0 million of royalties on public sector sales of Microsoft Dynamics AX by other Microsoft VARs, up 12.1% from $906,000 a year ago. Subscription revenues increased 27.9%. We added 35 new subscription-based arrangements and converted 18 existing on-premises clients, representing approximately $27.2 million in total contract value. In Q3 of last year, we added 38 new subscription-based arrangements and had 11 on-premises conversions representing approximately $16.7 million in total contract value. SaaS clients represented approximately 22% of our new software clients in the quarter, compared to 34% in the prior year quarter. SaaS contract value represented 30% of the total new software contract value signed this quarter, compared to 28% in Q3 of 2014.
The value-weighted average term of new SaaS contracts this quarter was 5.8 years, compared to 5.5 years in last year's third quarter. The fastest-growing subscription-based revenue stream continues to be from e-filing for courts and online payments. These revenues increased 34% to $11 million from $8.2 million last year. Total e-filing revenue of $8.4 million this quarter grew 36.9% over last year, with 19% of that increase related to our Texas e-filing contract, which contributed $4.8 million of revenues this quarter. Our blended gross margin for the quarter declined 40 basis points to 47.6%, mainly due to continued onboarding of professional services and development staff to support our current backlog and anticipated new business. Since September 30th, 2014, our implementation and development staff has grown by 182 employees. Our non-GAAP gross margin declined by 20 basis points to 48.6%.
SG&A expense increased 16.5% and was 21.1% of total revenues, an improvement of 20 basis points from last year's third quarter. Excluding non-cash share-based compensation expense and acquisition-related costs, SG&A expense increased only 11.7%. Operating income was $31.5 million, an increase of 17.7%. Non-GAAP operating income was $39.3 million, up 21.5%. Despite slightly lower gross margins, the non-GAAP operating margin improved 100 basis points to 26.1% as we achieved substantial leverage from both SG&A and R&D expenses. Net income rose 18.5% to $20.1 million, or $0.55 per diluted share. The fully diluted share count increased by approximately 1.1 million shares, primarily from stock option exercises and, to a lesser extent, stock issued in acquisitions. Our effective tax rate was 36.5% and benefited from a higher qualified manufacturing activities deduction.
Our effective tax rate may increase during the fourth quarter as stock option exercises increase and generate significant excess tax benefits that limit this deduction. Free cash flow was $52.7 million, compared to $64.7 million in last year's third quarter. Days sales outstanding and accounts receivable were 77 days at September 30th, 2015, compared to 78 days at September 30th, 2014. DSOs decreased sequentially from 94 days at June 30th, which is our normal seasonal trend related to the timing of maintenance billings. Our backlog at the end of the quarter was $757.7 million, a new high, and was up 12.4% from last year's third quarter. Software-related backlog, which excludes backlog from appraisal services contracts, was $707.7 million, an 11.6% increase. Backlog included $171.9 million of maintenance, compared to $152.1 million a year ago. Subscription backlog was $236.9 million, compared to $194.7 million last year.
Our bookings for the quarter, which are calculated from the change in backlog plus revenues, were $186 million, up 25.7%. On a trailing 12-month basis, bookings rose 5.5% over last year. We signed 28 new contracts in the third quarter that included software licenses greater than $100,000, and those contracts had an average license of $579,000, compared to 30 new contracts with an average license value of $475,000 in the third quarter of 2014. Our guidance updated for the full year of 2015 is as follows. We currently expect 2015 revenues will be between $578 million-$583 million. We expect 2015 diluted GAAP EPS will be approximately $2.01-$2.07. We expect 2015 non-GAAP diluted EPS will be approximately $2.56-$2.62. For the year, estimated non-cash share-based compensation expense is expected to be approximately $20.3 million-$20.8 million.
Fully diluted shares for the year are expected to be between 36 million-36.5 million shares. We estimate an effective annual tax rate for 2015 between 36.5%-37.5%. The tax rate and share count each are affected by the timing and volume of stock option exercises. We expect our total capital expenditures will be approximately $14 million-$15 million for the year. Total depreciation and amortization is expected to be between approximately $15.5 million-$16 million, including approximately $7 million of amortization of acquired intangibles. Note that this guidance does not include any impact from the proposed acquisition of New World Systems, as the completion and timing of the acquisition is subject to regulatory approval and customary closing conditions. Now I'd like to turn the call back over to John for his further comments.
Thanks, Brian. We've reported for some time now that the markets have recovered from the 2008 financial disruptions and been behaving relatively normally. In the past several months, we've actually experienced at least a modest acceleration in activity. RFP activity in Q3 was clearly ahead of longer-term run rates. It's a short period of time to draw any conclusions from, but directionally, we are encouraged. I would characterize our competitive position as steady at a strong level and attribute the higher licensed revenues to a marginally stronger market. We continue to work toward closing the New World Systems deal in the fourth quarter. Since signing the definitive agreement, we've had more exposure to their team and continue to be impressed. Along with the obviously strong industry knowledge and strong competencies in the team, there is genuine excitement regarding the combination.
The early reaction from clients and prospects has been that they are excited about the complementary nature of the combination, positioning Tyler to provide the most comprehensive offering in the market, which will help government be more productive for their citizens. Chad, we'll take questions.
Thank you very much. We will now begin the question and answer session. To enter a question into the question queue, please press star, then one on your touch-tone phone. If you are using a speakerphone, please pick up your handset and then press the star key and the number 1. To withdraw your question, please press the star key, then the number 2. Please limit your question to one and one follow-up, and then place yourself back in the queue for additional questions. At this time, we will pause momentarily to assemble that roster. Our first question comes today from Charlie Strauzer with CJS Securities.
Good morning. John, you talked about the pickup you're seeing in the RFP space, RFP pipeline, I should say, in Q3. Can you give us a little bit more granularity in terms of what areas you're seeing the pickup in? Is it more courts-related, financial, et cetera? Also, looking into Q4, is that pace staying where it was in Q3?
Courts is still a smaller market. Any trends there have to be longer term, otherwise they're pretty anecdotal. It's really more on the financial side of the business where the volume of activity is large enough that even shorter swings are interesting to us. I guess I'm talking more about the financial side, and it just seemed that there was a lot of RFP activity and a lot of activity that I think is worth noting in the third quarter. Again, there's ebbs and flows here, and maybe it goes right back to the normal level. Everybody wants to watch the local government marketplace, and there's always some pressure on their budgets. Again, in the short term anyways, what we're seeing for activity in the marketplace suggests that it's going to remain at least steady, if not accelerate a little bit.
That's somewhat encouraging to us.
Are you seeing these more larger municipalities or agencies that are putting these RFPs out, or is it just a wider breadth of RFPs that you're seeing?
It's a wider breadth, as you saw, as I think Brian just mentioned, the average software license fee in our over $100,000 category went up about $100,000 year-over-year. There's pretty good activity on the higher end of our range in our addressable market. I do think over a long period of time, we've consistently been becoming more and more competitive on, again, the higher end of our range, which is not the ultra-high side of the market where we don't play as actively, but really this tier 2 into the lower end of tier 1 space. I think Tyler's competitiveness has consistently improved.
Great. Thank you very much.
Thank you.
The next question comes from Brian Kinstlinger with Maxim Group.
Great. Thanks so much. I wanted to start with e-file. It's been such a good business for you. I'm wondering, as you look at your e-file install base, especially the large counties and states, do you expect any are going to mandate e-filing in 2016? Maybe specifically also touch on L.A., where you are with that process and install.
Predicting exactly when certain counties or states go mandatory is difficult. Even if they have a clear intention, some of them have legislative processes they need to go through. Not to avoid the question, Brian, but it'd be hard to be that specific for you. It is our clear perception that most of these clients, say, for example, most of the counties in California that are in the midst of their case management implementation, have the expectation that at some point in time, as their case management systems are in place, that they'll implement e-filing, and that they'll ultimately make it mandatory.
I think the general atmosphere out there, that when people have good back-end systems in place, that they intend to move forward with e-filing, and ultimately appreciate that for them to get high adoption and to become a paperless courthouse, they need to implement mandatory, and we're seeing a clear trend toward that. I can't give you quarter-by-quarter which jurisdictions will do that, but it's the clear impression we have that the vast majority of our clients are moving in that direction.
Great. My follow-up: With more RFP activity that you've discussed, especially you mentioned the higher end picking up, how does Dynamics fit in your proposal plan? Should we see more direct sales from Dynamics, in your view, and maybe gaining more traction, or will you be continuing to propose Munis even at the high-end level, much more so than Dynamics?
Well, certainly our direct channel and our direct presence in the marketplace is considerably larger with Munis and considerably more established, and they're doing well in that space, we're certainly not going to back off that. We have identified a number of subsegments or certain areas in the marketplace where we believe Dynamics is competitive and can build momentum and grow a presence in the marketplace. We're focused on that with some direct resources. I think the growth in our sales channel around Dynamics is supporting their partners, both domestically and internationally, and at different levels of government: federal government, not-for-profits, higher ed, et cetera, agencies.
There's a pretty comprehensive plan that we've worked together with Microsoft on, and I think Tyler's-- you could look at it that for the last five or six years, our experience in government has been applied to the R&D side, and we're transitioning to where we'll have less of a role on the R&D side. We'll have a reduction in headcount there. We'll bring our market expertise to the go-to-market side and try to enable their partners to attack all those sub-markets and extended markets that we don't have a strong presence in at this time.
Great. Thank you so much.
The next question comes from Alex Zukin with Stephens.
Hey, guys. Thanks for taking my questions. Congratulations on another great quarter. It seems like from a SaaS perspective, you saw a lot more dollar conversions this quarter than even some of the new business. I guess I'm just curious, is there any trend that we can take away from that? Anything that's changing? Are we reaching a new inflection point? Then why the disparity in terms of the conversions versus the net new?
It goes up and down quarter to quarter, so you need to look at a number of quarters. Q2 really wasn't very good for newer conversions. Q3 was better, and Q4's outlook is pretty good. It bumps around a little bit. I think the way we've described it is, the local government marketplace, it's slower to make changes, that we're seeing a gradual shift in that direction. I think that's still accurate language for this, that we see traction in our installed base and in the new business market. We're adding, what, I think around 55 names, a little more than half of those new names, a little less than half conversions, and we're satisfied and happy with that, and it just gradually gains a little bit of momentum.
Alex, it really was weighted more toward the numbers we give in the remarks earlier, the dollar value of the SaaS deals. That $16.7 million in contract value was a combination of both the new and the conversions last year, and the $27.2 million is a combination of the two. It still is more heavily weighted towards the new customers. We did have a couple of very large new SaaS customers this quarter. I don't think there was a big change in the dollar value of the conversions.
Got it. That's helpful. Can you guys talk about the Cook County deal, how many of those types of deals are out there in any given year? How does that factor into how many of those do you think you guys do in any given year?
Not many. Historically, our mega deals like that have been courts. They're out there. I think our win rates are very good. The court side, Washington, Oregon, Maryland, those were all big statewide deals in the last few years, in this size range. Occasionally, they come around in tax and appraisal. Cook, but it's top 3 county, as we said. Our competitive position in those situations is very, very good. I think our win rates would be real high. There aren't a lot of companies that have our size and our resources and history and experience in that space. I think we compete very, very well when they come out. They're obviously going to be more infrequent. As a company, two, three kind of outsized deals is what we do in the course of a year normally.
Perfect. On New World, what's been the reception, I guess, from prospective customers around the acquisition in the sense that, as you've continued to meaningfully increase your breadth of offerings, is it changing the conversation with prospective customers in any way in terms of size of initial wallet?
Yeah, no, it's been very positive, the initial reception. As we know that there's a little overlap between some of our products and some of their financial applications, but it really isn't that significant in the overall deal. The excitement is around the complementary nature of the deal. For our clients to have an industry-leading public safety system available to them that we clearly intend to integrate more seamlessly over time and add value to their existing solutions for their public safety clients. We've heard from clients who said, "Hey, we were looking for one or the other, and now we know we can get one that will be integrated and add value and make us more efficient." There's been a lot of that positive response. Even on the financial side, they have certain applications that are strong that we don't have.
We have certainly a lot of applications that they don't have that are on top of the core financials that will become available to these clients. The options that both client bases will have for complementary products has been what they're focused on, and it's been pretty enthusiastic.
Got it. Maybe just one last one for me. With respect to any trends, how insulated are you guys with respect to some of the macro events in the economy from state budgets that may be exposed to issues around commodities? Can you just walk us through the dynamics of why that maybe doesn't matter as much for you guys?
Yeah, I mean, over a long period of time, unfortunately, I have that perspective now of 30 years or more, it is very rare that, let's say, normal economic cycles impact our market. Some of that, we're just fortunate, and some of it's by design. Really, in the last 30 years, in my view, our market's been impacted twice. One was a technical issue with Y2K, the second was the 2008 financial crisis or disruption, whatever we want to call it. In 2008, it was extreme enough that state revenue sharing and federal revenue sharing going to local governments at least got threatened and in some cases got impacted. Some of these projects were put on hold, in recent years, those projects have been executed because they're essential, the market's been pretty good.
Your typical ebbs and flows generally don't affect us for two reasons. First, local government generally funds these types of really general fund types of investments through their own direct revenues, which are property taxes, utility revenues, the direct revenues to local government that don't get impacted, right? I mean, all of us pay less when we have a year where we earn less, but we pay the same property tax bill that we have on the house we own, we pay the same water bill. Those revenues are much more stable than state and federal revenues, where sales tax and income tax can be more volatile. The second reason is that everything we do, and this is the part that would be by design. Everything is an enterprise solution that's important to them, and it's essential.
They have to do it, whether it's printing tax bills or running payrolls or managing the courts. This is not discretionary and has to happen when budgets are flush and when budgets are tight. Generally, we're impacted very little with the couple of exceptions that I noted.
That's very helpful. Thank you, guys.
Sure.
Our next question comes from Kirk Materne with Evercore ISI.
Thanks very much. Good morning, guys.
Sure.
I guess, John, my first question would be, as you guys have grown and you're adding New World to the mix here, I was just curious on your view of the ability for you all to start having a bit more of a broader channel of partners, especially services partners. The bigger GSIs have generally not focused on state and local, or at least local governments. It's more federal and state level. You guys are clearly showing that there's a lot of business to be done with more local municipalities and a lot of things you guys are doing, like e-filing or pretty transformational type of projects.
I'm just curious if, over the next year or two, maybe not in the immediate near term, but as you put New World together, is there an opportunity to maybe start to get some greater distribution and maybe services leverage out of more services partners or integrators?
It's a good question, and it really points to a conscious decision on our part that differentiates us from many of the other players. I think what you're saying is you guys are evolving into a more substantial software company. Obviously, a lot of the software companies you follow use partners to get leverage in their service channels and presence out there in the marketplace. Yes, we're a big enough company now that I think we could attract legitimate IT service integrators to implement our systems. It's a pretty conscious decision on our part to have not gone that direction. This is something, when we're selling our systems, that we focus on a lot, and that is that when we go out and bid a deal, we own that deal.
It's not just our software, it's the conversions, it's the project management, it's the implementers, it's product extensions that may need to be done. The success rate, in our view, is considerably higher than when you have an integrator and a software company and multiple contracts or elements of contracts and some areas that aren't as clear as to who actually owns that responsibility. Post-implementation, whatever was done in the implementation, whether they're product extensions or the way the product was implemented, is much more completely transitioned to post-implementation support relationships. If you were to be hearing what we're telling our marketplace, it's that having the IT service side and having a complete one throat to choke approach differentiates us. We announce these new deals, focus on California courts, and to the market, they can add up the contracts and see where we're going directionally.
There's an incredible execution part of that business, and as important to having won the business in the first place is successfully executing on those projects, which we have a very good record on. Obviously, one feeds the other. The success in the market leads to new business. You make a very good observation, Kirk. We'd have higher margins if we didn't have as big a professional service side of our business. The business matrix may look a little better, but in our view, it's a strategic part of our offering that differentiates us, especially from tier 1 software providers.
That makes sense. Maybe just stripping out the margin dynamics of it. I guess my question is more about just geographic reach and influence, meaning, let's just take e-filing, for example. If you had a bigger, say, global or national, or I guess national in your case, partner working with you, do you think there's a way to get to more opportunities faster? Do you think this is just a market where it is a slow and steady wins the race situation? Having a bigger, more national brand from an integration perspective, helping you get in front of more decision makers potentially faster isn't something that's necessarily required, and when you're thinking about these more strategic, more transformational deals.
I think our bias in our current end market is to continue to do most of that directly. It's not like we have a bright line where we wouldn't partner with somebody who had relationships or presence in certain markets. Generally, our bias, and I feel certainly in courts, because that's a pretty well-defined and somewhat limited market, I think we're trying to manage our sales channel and our service channels to be able to address all the market that's out there. I think we really know the states and major counties that are coming out in the coming really three, four, five years and feel we have the capacity to address that. You mentioned international. I think that, for a lot of reasons, could be a place that we might partner more. Obviously, culturally and presence and relationships and a lot of things that we could leverage.
As we go that direction over a long period of time, probably a little more of it there.
Okay. I'll leave it to others. Thanks very much, John.
Sure.
Thank you. Our next question comes from Scott Berg with Needham & Company.
Hey, John and Brian. Congrats on another nice quarter. Thanks. Two questions for me. First of all, John, your tax and appraisal software business was a laggard in the business a couple of years ago. Obviously, we've seen a lot of larger deals the last couple of years, whether it's New York City or the $30 million deal you announced in the quarter there. How do you view that business on a go-forward basis, maybe over the next one to two years? Can you see some of the similar types of demand trends like you're seeing, maybe in general, in courts and justice near-peer? Is that maybe just a short-term impact to the company that you've seen recently?
Well, it's a good observation. There's no question that, I think it was 2006, that they kind of got off the track a little bit, and we had to rein that division in, and there was even some pressure to get out of that business, because it didn't have as much growth, and the appraisal service side wasn't completely consistent with what we did. We have looked at it for that period of time, the last seven, eight, nine years, as a sticky part of our business. As I said earlier, it's tax revenue. It's important, to have a presence in that office is important, even if it's not as robust a business for us. We always looked at that as a lower grower and margins getting diluted somewhat by the appraisal service side of things.
Hasn't been the case, obviously, this year or maybe the last 18 months, it's a good question. Is that a blip? At least for, let's say, the next 18 months, it'll continue. There'll be higher growth than there have been historically. Probably should grow at least at or maybe above Tyler's average growth across the company. Certainly, on the software side of the business, which used to be half of the business and now is, I think about 70% of the business, margins will continue to benefit from scale and expand. That business is definitely outperforming our long-range forecast in terms of both growth and margin expansion. We think for the foreseeable future, to 18, 24 months, that'll continue. Hard to know beyond that.
Great. A follow-up for Brian. Brian, you've historically talked, at least over the last couple of years, on the company's desire to get operating margins above 30% and ways you can get there over the next couple of years. Obviously, the New World Systems acquisition will be accretive to your margin profile and probably helps you get there a little bit more quickly. How do you view margins maybe two to four years out, more longer term now, A, with that acquisition, and B, with some of the other leverage success that you're currently having?
As we talked about in the New World acquisition announcement call, New World does have margins above our current blended gross margins, but their margins are consistent with a similar business within Tyler, that has a lot of scale and has a high degree of recurring revenues from a single product. They will be accretive to our margin profile, but they're not really out of line with where parts of Tyler are. Our long-term goals on margins have been very consistent over a number of years, and those still are in place. That we believe that if we can grow in the low to mid-teens, that we get meaningful margin expansion at the gross margin line of 100 basis points a year or better. That would be an annual average. As you've seen, it doesn't happen necessarily in a straight line.
There are years where they're flat or with more pressure on gross margins as we have this year, there are years where we have 200 and 300 basis points of margin expansion. Those long-term expansion goals, we believe, are still consistent with what we've done historically in the past, and that we have a lot of gross margin improvement opportunity. Some of that coming from New World, but certainly in Tyler's businesses as other businesses, like our courts and justice business, continue to gain scale, have new higher-margin revenue sources, such as e-filing, start to layer in there. As the recurring revenues, which are higher margin, continue to build to become a bigger piece of the product or the revenue mix. As we continue to move beyond the investment stage in some of our newer products, like our EnerGov product, and those margins start to be enhanced.
All of those things are contributing factors to this long-term 100-plus basis point annual margin expansion, assuming growth consistent with what our historical growth has been. As we've said, we believe that we can get substantial leverage from both SG&A and R&D, the two things below the gross margin line, that translate into higher operating margin expansion. We've seen that, for example, this quarter, where we actually had a little bit of a pullback in the gross margin, but we still got 100 basis points of operating margin expansion, because SG&A and R&D are both growing at a much lower rate than our revenue growth is. We believe that those trends remain in place. Again, they're not necessarily on a straight line, so there's sometimes when we're above that profile and sometimes when we're below it.
That's how we expect to continue to drive margin expansion in the long term and move from this mid-25%, 26% operating margin non-GAAP that we currently have to 30% and north of that. As we said, there are parts of our business where we're even above that target
currently, we have a plan to move other parts of our business more in line with that.
Great. That's all I have at the moment. Thanks for taking my questions.
The next question comes from Jonathan Ho with William Blair & Company.
Hey, guys. Let me echo my congratulations as well. Just wanted to start out, can you just give us a sense of how much is left in backlog, from the Texas e-file and when we could maybe anticipate another extension of that?
Sure. That contract was initially a four-year contract, and it currently has just shy of $37 million of remaining backlog as of September 30th. That's currently playing out at about $4.8 million a quarter. It really stays at that level. It takes a little bit of a step up, a very minor step up in 2017. The contract runs through September of 2017 and, like I said, $37 million of backlog left. It's about halfway through right now.
Got it. Oh, go ahead.
No, I expect that we certainly have a close relationship with Texas. We had a big event recently where we celebrated the go-live of Texas e-filing in all 254 counties. It's several months ahead of schedule when those last counties went live. That project is working extremely well. The chief justice of the Supreme Court held a press conference and celebrated the success of the project. It's obviously working very well, and I expect that before we get too close to the end of the contract, we'll have discussions with them about extending it. The contract provides for a series of one-year renewals in the original contract, but we're still a little bit off from approaching the end of that.
Got it. Just wanted to understand, just in terms of, I guess, the staffing level increases that you guys talked about in terms of headcount. Have you been able to hire enough people and how comfortable are you with the headcount levels, relative to the expense side, now that you've increased it over the period of this year?
Yeah, we've been in a growth and recruitment mode for a long time. I think our HR side of the business has got recruiters embedded in all of these different divisions. It's an active machine. Generally, sometimes when you see operating profit at a higher level than, say, the beat on the revenue, in other words, more falling through, a lot of that is sometimes that you almost always trail behind. The headcount growth we have in the fourth quarter probably won't be met. It's certainly not a problem. Tyler's an employer of choice in all of our major geographies. We recruit aggressively, and we have a strong presence in the marketplace. It's a matter of timing. Like I said, sometimes you schedule positions, and it's 30, 60 days later.
We certainly don't see ourselves as looking at those pools as having run out and it being a long-term problem. It's just an ongoing part of our business.
Got it. Just one last one, if I may. In terms of Microsoft, has there been any sort of update there in terms of the maybe wind down of the relationship or reallocation of resources? Just want to get a sense of what's happening there.
There really hasn't been anything definitive done since the last call, say. The general direction of the relationship that we've reported is still our expectation, which would be considerably lower R&D headcount and spend, and some increase, as I said earlier, on the sales side and the service side of things, but overall, a net decrease in heads and costs for us. Revenues are not explosive, but they're going in the right direction. The performance of that business should continue to improve.
Great. Thank you.
The next question comes today from Tim Klasell with Northland Securities.
Hey. Good morning, everybody. My congrats on the quarter as well. Most of my questions have been answered. You mentioned the RFP pipeline has been building out nicely. As we look out to 2016, could that change the seasonality? Do you guys have any feeling that, gee, there's a certain quarter or two where a lot of these deals may close or a large one, or is that just too difficult to judge at this point?
It's probably too difficult to judge, and it should continue to level out. The recurring revenues as a percentage of revenues at Tyler are so significant. The bigger deal experience, which is mostly POC accounting, is pretty straight line as well. The sell, deliver, and recognize licenses is becoming a very small percentage of our overall business. Therefore, I think that's why you're seeing this predictability, these marginal beats. They're really getting into a pretty tight range, and I think that's a function of the maturing of the business overall. High recurring revenues, more large deals coming out of percentage of completion, and the impact of licenses within a quarter being less in terms of total influence on the numbers.
Okay. This on a specific deal-related question in Cook County. Obviously, their systems were ancient. Was there a specific catalyst that happened where they suddenly said that we really had to modernize their systems?
I don't know of a specific catalyst. As we indicated, it's a 40-year-old platform, and I'd say it's been a number of years in the making. This was a long project for them to create, design, manage the scope, and it's been a several-year process at the least. Just time to make a change.
Okay. Thank you very much. That's helpful.
Sure.
The next question is from Kevin Lu with B. Riley & Company
Hi, good morning. Just one question on the subscription business. You talked about the growth there being driven by both e-filing as well as online payments. Wanted to clarify whether the online payments piece is distinct from the e-filing transaction fees you get. If so, what products those are tied to, the size of that business, and how much growth you're seeing there.
Yeah, a little of both. Online payments is really how the e-filing revenue is captured. I think we mean that more. We do have some online payments business as well, but it would be very insignificant compared to the overall e-filing business.
Yeah. For example, this quarter, e-filing was about $8.5 million of revenues. Online payments separate from that is about $2.5 million. Online payments is primarily where we process either traffic tickets or utility bills, in many cases for smaller clients who don't want to manage that website themselves, but use our software, and we get a convenience fee for that. Because it tends to be more with the smaller clients, it's not as nearly as fast-growing business as the e-filing. Most of that growth is on the e-filing side.
Got it. Also one quick one on Dynamics. Just the royalties there seem to be on a little bit of an upswing. As you start to transition over to doing more sales and support of the VARs, do you feel like you'll start to get better visibility there? Do you expect the current run rate of revenues to continue?
No. We really don't have any better visibility. I think as their footprint and presence in the market continues to mature, hopefully the consistency and the direction of it is a little bit predictable. We don't have any specific insight into the activity in that channel.
All right. That's all I had. Thanks so much.
Sure.
The next question is from Peter Lowry with JMP Securities.
Oh, hi. Great. Thanks. Just one quick big-picture question. Can you recap just what the greatest demand drivers in state and local government software are right now? Then looking forward, say three to five years, do you see any change in what the drivers might be?
Not really. Again, it's what we say, it's a steady market. These are all enterprise essential apps. There's a huge inventory of systems out there that are aging and not well-supported. Every year, a small percentage of those go back out in the marketplace. It's our hope and expectation that this continues to be a pretty steady market.
Okay, great. Thank you.
At this time, there appear to be no further questions. Mr. Marr, I'll turn the call back over to you for closing remarks.
Okay. Thanks, Chad, and thank you to everybody participating on the call today. We appreciate it, and if you have any further questions, feel free to reach out to Brian or myself. Thank you very much and have a great day.
Thank you, sir. That concludes today's call. Thank you for attending. You may now disconnect.