TYLER TECHNOLOGIES INC Q3 FY2024 earnings call

• The third quarter had strong top and bottom line performance with non-GAAP operating margin expanding to 25.4% and free cash flow reaching a new quarterly high. Recurring revenues grew 12.1% and SaaS revenues grew 20.3% for 15 consecutive quarters. • Public sector market is robust with focus on modernizing systems via cloud adoption, and new software bookings were strong with SaaS contract value up 78% year-over-year. • Made progress with cloud optimization efforts, version consolidation, and client-driven SaaS adoption. 100% of public safety new contract value was SaaS in Q3, and 108 flips of on-premises clients were signed with increased contract value and ARR. • Courts & Justice business was active with large deals like Kentucky Court of Justice and Phoenix, Arizona Municipal Court. • Cross-sell activity was strong with deals like Texas Office of Court Administration and Illinois Department of Financial and Professional Regulation. • Payments business had 268 new payment deals and expanded in various regions.

Total revenues for the quarter were $543.3 million, up 9.8% and organically grew 9.4%. Subscriptions revenue increased 17.6% and organically rose 17.3%. SaaS revenues grew 20.3% to $166.6 million and grew organically 19.7%. Transaction revenues grew 15.2% to $180.5 million. Recurring revenues grew 12.1% and comprised 85% of total revenues. Total annualized recurring revenue was approximately $1.85 billion, up 12.1% and organically grew 11.8%.

• Total revenues expected to be between $2.125 billion and $2.145 billion, midpoint implies 9% organic growth. • Non-GAAP operating margin expected to continue expansion. • GAAP diluted EPS expected between $6.13 and $6.28; non-GAAP diluted EPS between $9.47 and $9.62. • Free cash flow margin expected between 21% and 23%, including estimated impact of incremental cash taxes related to Section 174. • Replaced $500 million unsecured revolving credit facility with a new $700 million facility maturing in 2029.

• Flips and SaaS revenue growth can be lumpy. • Competitive landscape could change with increased competition from players like ServiceNow and Workday. • ARPA funds usage and impact on deals can be uncertain. • Labor market and internal initiatives can affect professional services margins. • Timing of SaaS revenue recognition and go-lives can vary, impacting sequential growth. • Prepayments like the Kentucky deal are one-off and not typical, which could affect cash flow projections.

Q: Lots of momentum this quarter on the cloud side. I wanted to maybe dive into that 3 times on the TCV of flips up to $36 million. Do you think this is a new run rate? Or is this just more of a one-off quarterly dynamic here?

A: As we said, these can be a little bit lumpy. This was a strong quarter with some larger flips, but that's a trend we're seeing, more of our larger customers that have been slower to flip to the cloud are now starting to move at a faster pace. We should expect to continue to see growth in the flip volume and the size of flips, but it could be lumpy from quarter-to-quarter.

Q: I'd be curious in terms of what you saw of sales linearity throughout the third quarter and maybe into October? And are you seeing at least lately any pressure of maybe decisions not being made until after the election? Or any impact there?

A: We're actually not seeing any slowdowns or hesitations due to the election. Generally speaking, most of our divisions are either at or exceeding their sales plans for the year. We're not seeing any slowdown at this point or any pauses due to any macro factors or the election.

Q: I had a question about the incremental competition during the quarter. Are you seeing more pressure from players like ServiceNow and intelligence and analytics, in Workday in ERP?

A: I think generally stepping back, the competitive landscape is has been pretty neutral throughout the year. I wouldn't say there's been any significant increased competition or any decreased competition. Our win rates have generally been consistent.

Q: On the transaction business, ARR there are meaningful, we're used to seeing that may be down sequentially in 3Q, and it was up this year. Any drivers of the transaction revenue base?

A: I don't think there's really a change in the seasonality. It's a combination of new business as well as increased volume. We're seeing greater adoption through our client base, and we're working with our clients to help them get more of their citizens doing things online and running through our systems. The California State Parks contract going live and Florida payments contract going live are examples of drivers.

Q: After being at the IACP event here, one of the topics that came up was where customers are at in terms of version consolidation. Just wanted to get an update on some of the key product areas where we are at with that.

A: Version consolidation is a big piece of our cloud transition. We're ahead of where we thought we would be. Each of our flagship products have been going at different paces. We're making good progress and expect it to continue to help gross margins as we look towards our Tyler 2030 goals.

Q: Given your experience in the space, we're clearly in a really healthy part of the budgeting cycle and the willingness to spend cycle across state and local governments. How should we be thinking about the sustainability of some of the healthy demand that you're seeing? And maybe just level set us on the ARPA funds, how much of a benefit do you think that you're seeing today versus how much could you see in 2025 and 2026 as the funds that are committed to actually get spent?

A: Our outlook right now and what we're seeing in leading sales indicators is we see that level staying for the foreseeable future. ARPA funds have been an interesting topic. There are certain deals driven by ARPA funds, but we can't draw a direct correlation over the last few years of ARPA funds to Tyler's performance in a material way. It has definitely been part of the overall environment but not a major tailwind to growth in sales.

Q: Tyler's services has always been really important for your government customers. But it's been interesting to see that business over time grow just a little bit slower than the rest of the software business. So maybe the question is, could you maybe speak to how the services intensity in the business is changing as Tyler becomes more of a SaaS company, and maybe relatedly, how that impacts margins over time?

A: Our services gross margins have improved due to management focus. Services are expected to remain relatively flat or decrease a little bit in the future. Services are lowest margin, so less services in the mix will have a positive impact on margins as they are lower margin.

Q: When you talk to clients who are somewhat hesitant to flip, what are some of the reasons why they're so cautious? And ultimately, how do you convince them otherwise?

A: Some reasons are historic reasons like control. As we see neighboring jurisdictions making successful decisions and our execution, it helps break down barriers. We also talk about aging technology and infrastructure leading to more openness to flips.

Q: Can you give us a little bit of sense around the AI opportunity? I think you referenced one large deal and how your customers are maybe thinking about leveraging AI over time and what that means from an upsell perspective?

A: We're starting to see a little bit of questions in RFPs around AI. We're focusing on where to put resources behind AI. Customers are starting to be more open about talking about AI, but it's not a driver right now in deals. There are opportunities for upsell as clients start to consider AI's applicability.

Q: In terms of like the acquisition front, you've got favorable debt terms, you're generating a good amount of cash. How are you guys thinking about acquisitions now? And then in terms of more specifically, is there specific end markets within your business that you're thinking that could benefit from acquisitions more than others?

A: Our priority is debt pay down. We're looking at acquisitions and may be a little pickier now. We're discussing internally what's the best area for us to go get our bang for a buck. No specific end markets are identified yet but discussions are ongoing.

Q: Building on the earlier question on version consolidation which has been somewhat of a gating item to get customers to migrate to the cloud. Could you just discuss some of the characteristics that you're using to encourage customers to move to the latest product release?

A: There's a combination of things. Some are minor financial considerations, some are new features only available in the cloud, and some are sunsetting older versions with ample notice. It's a variety of things as each product is in a different stage.

Q: A question for Brian on the sort of the pace of the SaaS revenue I know you had quoted that the volatility of SaaS revenue, the timing of the go-lives from booked to a live system can be variable. But I just wanted to ask, we have 2 years now where the sequential growth in Q3 is the highest. I wanted to understand if that's purely circumstantial if there's any emerging seasonality to those go live.

A: It's probably more circumstantial. It varies by market and customer. For example, in the schools market, there's a big push in Q2, but for other markets, it's more about timing and bigger customers.

Q: Congrats on another solid quarter. I'll ask maybe a longer-term question. I think it's been alluded to a little bit. But again, as we think about AI, both agentic, copilot or system and you think about the customers that are starting to ask those questions. You think about the breadth of solutions that you're offering, both to your customers and across the portfolio of products. As we think about that monetization pathway, is that something we should think about maybe on top of the long-term guidance that you provided at the last Analyst Day through 2030, or is that embedded in there?

A: When we gave our 2030 targets, we did not bake in efficiencies, internal efficiencies on any gross margin lines that were going to be driven by AI nor did we really bake in any sales that were really a result of either new products, products, newly developed products or newly acquired products. AI benefits, if any, are not significantly baked into long-term targets.

Q: And to what extent, maybe this is just a clarification. To what extent are you hearing or seeing in sales cycles that those types of questions are actually facilitating or we're amplifying flips or converts either the timeline around them or the momentum or enthusiasm. And then on free cash flow, Brian, again, I think the outperformance obviously both in the quarter and the guide for the full year, very notable. You noted that one Kentucky prepayment contract. How do we think about like when, where and like why those prepayments happen. And more so, as we look to '25 and beyond, is there any reason to assume that those would happen more frequently or less frequently and kind of changing the complexion of the free cash flow margins.

A: Clients aren't looking for AI for AI's sake but there are ROIs involved. The Kentucky prepayment was a one-off. The transaction business has positive cash flow characteristics as revenues are typically paid quickly. The transaction business is a big driver of improved margins and cash flow. Prepayments like the Kentucky deal are not typical and won't change the complexion of free cash flow margins significantly in the future.