Tyler Technologies, Inc. (NYSE:TYL) Q3 2023 Earnings Call Transcript
Tyler Technologies, Inc. (NYSE:TYL) Q3 2023 Earnings Call Transcript November 2, 2023
Operator: Hello, and welcome to today's Tyler Technologies Third Quarter 2023 Conference Call. Your host for today's call is Lynn Moore, 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. In order to address your questions and stay within the allotted time, please limit your questions to one question per person. [Operator Instructions] As a reminder, also, this conference is being recorded today, November 2, 2023. I would like to turn the call over to Hala Elsherbini, Tyler's Senior Director of Investor Relations. Please go ahead.
Hala Elsherbini: Thank you, Aaron, and welcome to our call. With me today is Lynn Moore, our President and Chief Executive Officer; and Brian Miller, our Chief Financial Officer. After I give the safe harbor statement, Lynn will have some initial comments on our quarter, and then Brian will review the details of our results and provide an update to our annual guidance. Lynn will end with some additional comments and then we'll take questions. During this 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 those projections.
We would refer you to our Form 10-K and other SEC filings for more information on those risks. Also, 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. A reconciliation of GAAP to non-GAAP measures is provided in our earnings release. We've also posted on the Investor Relations section of our website under the Financials tab schedules with supplemental information, including information about quarterly bookings, backlog and recurring revenues. Please note, there have been minor re-classes between historical SaaS and transaction-based revenues on the supplemental schedule as a result of the recent transition to our new financial systems.
On the Events & Presentations tab, we have posted an earnings summary slide deck to supplement our prepared remarks. 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. Lynn?
Lynn Moore: Thanks, Hala. Our third quarter earnings and cash flow surpassed expectations and reflect a continuation of execution at a high level on key operational initiatives. We achieved strong performance across several of our key metrics with double-digit recurring growth and free cash flow growth of more than 40%. Our recurring revenue mix rose to 83.4% of our total revenues with SaaS revenues up 26% organically. This was our 11th consecutive quarter of SaaS revenue growth of 20% or more and exceeded our near-term growth expectations of a 20% CAGR in SaaS revenues through 2025, as outlined during our June Investor Day. We also achieved solid growth in our transaction-based revenues, which were up 8.5%. While operating margins this quarter declined slightly from last year as expected due to our cloud transition, margins were ahead of plan as a result of our operating efficiencies and expense management, especially around cloud operations.
It is encouraging to see margins hold essentially flat with last year even as we made considerable progress in our cloud optimization and cloud transition efforts, establishing a clear road map for operating margin improvement in 2024. The third quarter presented a very difficult comparison for our new software contract value and mix as last year's third quarter included two very large SaaS contracts that totaled $70 million in contract value. As we discuss regularly, the timing of large deals such as the two signed in last year's third quarter can cause significant lumpiness in our new software bookings. We're continuing to see a healthy public sector market environment and our new business pipeline is active. Leading indicators RFPs and sales demos remain strong with deals generally moving through the pipeline at a normal pace, which is often a 12- to 18-month procurement process.
Overall, our competitive position and win rates are strong with growing momentum in cross-selling activities, a key value creation lever. Additionally, our transaction business continues to capture higher volumes as we gain traction with our unified payments solution. I'd like to highlight some of our significant third quarter wins, which included a number of cross-sell opportunities. We continue to build momentum with our public safety solutions. Key third quarter wins include the Naperville, Illinois Police Department for integrated public safety suite including CAD, records management and e-citations. Naperville is the fourth largest city in Illinois, a state where we also have a strong presence with our Enterprise Justice solution. We're also pleased to see SaaS adoption growing and acceptance in the market with several cloud contracts signed during the quarter.
We continue to gain traction with cross-sell wins under our digital solutions division, formerly NIC, and our state enterprise agreements. Under our state enterprise agreement in Utah, we won a cross-sell opportunity with the Utah Department of Corrections for our enterprise corrections electronic messaging solution. We also added deals for our application platform formerly entellitrak, under our state enterprise agreements in Louisiana and Indiana. In the federal market, we secured a significant license win with the US National Guard Bureau for our turnkey suite of workforce case management applications. This is our largest workforce case management application within the Department of Defense and is another marquee win that spans 54 US states, territories in the District of Columbia that will be hosted in our FedRAMP-certified private cloud.
We signed a five-year multi-suite SaaS contract with Port Angeles, Washington, which includes our enterprise ERP, enterprise permitting licensing and cybersecurity solutions as well as payments. In the outdoor accretion space we won a competitive deal for accretion dynamic solutions with the Minnesota State Parks. In our Payments business, we signed a one-year extension for enterprise payment processing under our state enterprise agreement in New Jersey. In Harris County, Texas, the third largest county in the nation, added our digital jury solution, leveraging the disbursements capabilities that came to us through the Rapid Financial acquisition last year. Before I turn the call over to Brian, I want to highlight our recent acquisition activity.
As I said at our Investor Day, M&A is part of our DNA. And during the third quarter, we completed the acquisition of Computer Systems Innovations for approximately $36 million in cash. CSI brings AI-driven automation and enhanced document processing technology that can be leveraged across many of Tyler's vertical applications. It has primarily served the court technology space for many years, and we're excited about the opportunity to combine expansive footprint with CSI's expertise in AI and machine learning applications to elevate several of our other solutions. Earlier this week, we completed two other tuck-in acquisitions. ARInspect is a leading provider of AI-powered machine learning and data-driven solutions for public sector field operations.
ARInspect's advanced AI solution and expertise extends our applications platform with intelligent edge technology that can be leveraged across our state and federal verticals. ResourceX adds priority-based budgeting solutions to our entire ERP portfolio to address key challenges our clients face in their traditional budgeting process. The total purchase price for these two acquisitions was approximately $38 million in cash and stock. We're thrilled to welcome each of these companies and their team members to Tyler. Now I'd like Brian to provide more detail on the results for the quarter and our annual guidance for 2023.
Brian Miller: Thanks, Lynn. Total revenues for the quarter were $494.7 million, up 4.5%. Organic revenue growth, which also excludes COVID-related revenues, was 6.0%. Last year's third quarter included $11.7 million of revenues from COVID-related initiatives at our Digital Solutions division, all of which ended in 2022. Subscriptions revenue increased 16.1% and organically rose 14.7%. Within subscriptions, our SaaS revenues grew organically 26% and to $138.5 million. It is important to note that as our software contract mix continues to shift towards SaaS, our growth rate may vary from quarter-to-quarter due to the lag in time from contract signing to the start of revenue recognition, but we remain on track with our near-term growth expectations of a 20% CAGR in SaaS revenues through 2025.
Transaction revenues grew 8.5% to $156.7 million, up 6% on an organic basis. License revenue declined 47.9% as our software business continues to shift to SaaS. SaaS deals comprised 80% of our Q3 new software contract value compared to 91% last year. As we noted earlier, last year's Q3 included two large SaaS deals totaling $70 million in contract value. Professional services revenue declined 14.9% primarily due to the absence of COVID-related revenues and was flat organically. We added 161 new SaaS arrangements and converted 79 existing on-premises clients to SaaS with a total contract value of approximately $71 million. In Q3 of last year, we added 153 new SaaS arrangements and had 70 on-premises conversions with a total contract value of approximately $149 million.
Overall, our pace of on-premises conversions to SaaS continues at a steady pace with 246 slips year-to-date, and we expect Q4 conversions will be 100 or more. More importantly, the total contract value associated with flips has increased year-to-date to $58 million. As we've discussed, conversions are a significant growth driver over the next several years as we accelerate the pace of flips. Including transaction revenues, expansions with existing clients and professional services, total bookings increased 10.3% on an organic basis. Our total annualized recurring revenue was approximately $1.65 billion, up 11% and organically grew 9.8%. Operating margins were better than expected despite pressure from our ongoing cloud transition. Our non-GAAP OP margin was 24.8%, down by 10 basis points from Q3 of last year.
As we discussed in prior quarters, merchant and interchange fees from our payments business under the gross revenue model have a meaningful impact on our overall margins. In Q3, we paid merchant fees of approximately $36 million. If those fees were netted out of both revenues and cost of revenues, our consolidated non-GAAP operating margin for the quarter would have been approximately 190 basis points higher. Both cash flows from operations and free cash flow were robust this quarter at $177.5 million and $162.7 million, respectively, primarily driven by higher revenue collections. Cash flow in the quarter was impacted by approximately $22 million of incremental due to Section 174. On a pro forma basis, excluding the incremental Section 174 cash taxes of $112 million, our year-to-date free cash flow would be approximately $300 million, up 41% over last year.
We continue to prioritize repayment of our term debt as a use of our cash flow. And in Q3, we reduced our term debt by $135 million. We ended Q3 with total outstanding debt of $740 million and cash and investments of approximately $153 million. Our net leverage at quarter end was approximately 1.24 times trailing 12-month pro forma EBITDA. Our updated 2023 guidance is as follows: We expect total revenues will be between $1.942 billion and $1.962 billion. The midpoint of our guidance implies organic growth of approximately 7.5%. We expect GAAP diluted EPS will be between $3.82 and $3.96 and may vary significantly due to the impact of stock option activity on the GAAP effective tax rate. We expect non-GAAP diluted EPS will be between $7.66 and $7.80.
Interest expense is expected to be approximately $24 million, including approximately $5 million of non-cash amortization of debt discounts and issuance costs. Other details of our guidance are included in our earnings release and in the Q3 earnings deck posted on our website. In conjunction with our guidance for the full year, I'd like to remind you of the seasonality around our transaction revenues. While transaction revenues will grow year-over-year, as expected, they declined sequentially in Q3 and will decline sequentially again in Q4. Historically, transaction revenues are driven by two primary factors; state-determined deadlines like corporate filings and hunting seasons and the number of business days. Transaction revenues are typically at the highest in Q2, coinciding with peak outdoor seasons and tax deadlines.
Transactions are at a seasonal low in the fourth quarter with fewer business days and less activity around the holidays. As we noted previously, we are also seeing the revenue impact of a midyear contractual changes in one of our state enterprise agreements that include a move from a gross to net model for payments. Now I'd like to turn the call back over to Lynn.
Lynn Moore: Thanks, Brian. We're making solid progress every quarter to deliver our near and long-term objectives that we discussed in detail at our Investor Day earlier this year. Consistent with our track record, we continue to scale our enterprise while capturing more efficiencies as we transform into a largely pure cloud business, supported by a unified One Tyler strategy. Our strong year-to-date performance, underpinned by our powerful financial algorithm, strong balance sheet and our unique ability to deliver mission-critical software solutions, enabling the public sector's ongoing digital transformation. We're also proud that 11 of our state partners won E-Republic Government Experience Awards. Our clients in Utah, Mississippi, Indiana, Arkansas and Virginia swept the top 5 spots in the GovEx awards.
Our momentum continues to build as we complete this pivotal year in our cloud transition. Our team is excited about the tremendous opportunity ahead of us, and we look forward to sharing our continued progress as we finish out 2023. Now we'd like to open the line for Q&A
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